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FPM-Comment Reducing the Noise Martin Wirth: 1/2024 dated January 22nd 2024


The principle "boom nourishes boom and vice versa" is too short-sighted. A differentiated view


  • Divided development on the stock markets
  • Poor politics costs growth, impairs sentiment and thus determines returns on equity markets in the short term
  • Valuation across the board has almost halved in the last ten years
  • German investors are letting international investors get the better of them
  • Valuations should result in very solid returns

On the face of it, 2023 recorded significant gains at index level. However, the overall picture does not adequately reflect the development. After a broad-based upswing in the first half of the year, price gains in the second half of the year were mainly concentrated on the very large stocks, while the broader market stagnated or even recorded significant price losses. This also applied to stocks that were by no means disappointing in terms of their performance, but where there were negative surprises, the price losses were sometimes drastic. This once again created new opportunities. Towards the end of the year, portfolio adjustments were made which, in our view, clearly overshot the mark. Overall, the indices of highly capitalized stocks recorded disproportionately high gains.

Divided development on the stock markets

What led to this split development and how should we deal with it?

First of all, the economy disappointed. This was particularly true of Germany. The recovery expected in the second half of the year failed to materialize. This had an impact on corporate earnings on the one hand, but to a much greater extent on sentiment towards German equities in general and small and medium-sized stocks in particular. And the problem has a name, even if political stock markets are supposed to have short legs: The German government, which is at least on a par with the governments of other European countries in this respect.

Bad politics costs growth...

It pursues its ideology-driven projects unclouded by professional competence, (unfortunately unintentionally) turns de-growth fantasies into reality and is surprised at the lack of support from voters and their migration to other parties.

The administration is flourishing, as is the bureaucracy, which is by no means the fault of the current government alone, and one of the few sectors in Germany that is constantly expanding its workforce is the state itself. Unfortunately, this is not happening in areas close to the people, but rather in the public administration departments. There, people are obviously thinking of ways to make life a little more complicated.

Shutting down the last nuclear power plants in the middle of the energy crisis was obviously not a masterstroke from an economic point of view either. Especially when you then complain about the patchy availability of French nuclear power plants. It is no wonder that various energy-intensive companies have moved to other locations and don't want to wait for a possible lower and, above all, secure energy supply at the end of the decade. And contrary to what the government is spreading: Prosperity is not primarily earned in healthcare services and through public administration, but in industry. And if this disappears, there will be less to distribute.

The measures to eliminate the housing shortage were also successful, at least for owners of run-down properties, who do not have to fear any new competition on the rental market for the time being: First of all, pretty much every measure that can deter potential investors is discussed and partially implemented, from rent controls, protection against termination of tenancy, tenant participation in the CO2 levy, one set of regulations after another, garnished with rising interest rates, and then people wonder why new construction is collapsing. Since the state also wants to play landlord, it occasionally buys up a property that is then left to rot rather than being renovated due to a lack of money, as can be seen in Frankfurt.

The state always finds someone to blame for the weak development: Last year, the weak international economy, from which the export-heavy German economy suffered. For example, due to the weak growth in China, still only 5%. Oh well. And so, of course, the government continues to believe that the policy adopted is good, but suffers from poor communication. In other words: people are unfortunately a bit stupid, you have to explain it to them better, then they will finally understand the higher wisdom behind it.

All of this is quite entertaining if you are not affected yourself, but it also has an impact on the real economy. And is probably the main reason why Germany was at the bottom of the table in terms of growth last year. BUT: you can also see that a government policy, as long as it moves somewhere along normal, western and liberal lines, has a visible but limited impact on the economy. Assuming that the government's actions have cost a highly estimated 1% of national income, the damage amounts to €40 billion. That is a lot of money, but does not begin to justify the perception that the German economy is trapped in a deep and incurable crisis. A shrinkage of income, if you don't see growth as fundamentally undesirable, as some in the government do (even if you then formulate ever higher demands on the state and the general public yourself at the same time), is not nice. But not the end of the world: Germany generated a higher income in 2023 than in any year in history, with the exception of 2022.

Even if the German and European economies have become rather anemic over the years thanks to bureaucracy, constantly increasing taxes and levies and more and more regulations, a substantial amount of national income is still generated and distributed every year, and fortunately we can also participate in this distribution thanks to equity investments, among other things. Moreover, a further deterioration in government policy is not to be expected, as a lot has already been exhausted. And radicalization is also not to be feared, which is one of the advantages of the Chancellor. In this respect, the risk is very limited. If you want to assess the extent of the fall: at the beginning of 2022, mind you after the start of the Russian invasion of Ukraine, the German Council of Economic Experts was still expecting growth of 3.6% for 2023!!! The result, following a correct estimate for 2022, deviates from the estimate by a remarkable 4 percentage points. And this can be seen in the performance of the more economically sensitive sectors on the stock market since then. Which in turn means that the downward expectations are likely to be quite resilient. What is also ignored in the abbreviated view of "weak German economy = poor prospects for companies" is that listed companies are often globally positioned.

...and affects sentiment, which is the key component for equity market returns in the short term

However, the modest track record of both the German government and the European administration has come at a much higher price for investors in the short term than weak growth: as a result of the deterioration in sentiment, valuations for various market segments have shifted significantly downwards in recent years and in some cases are at all-time lows, which is all the more surprising given the continued availability of modest investment alternatives in the bond sector. This is in contrast to the general perception that equities are expensive. However, if Apple is worth more than the entire German equity market, which may well be the case and does not need to be discussed here, Apple's high valuation combined with its high index weighting does not necessarily mean that the entire US market, let alone the German equity market, is expensive.

A good part of this devaluation is therefore probably due to the perception of an extremely modest state of the German economy. Not only is this exaggerated, even though the sclerosis in Germany, as in Europe as a whole, has persisted for many years, it also primarily affects many companies that rely on the German market alone. Listed companies are generally international, often global, so the location of a company's headquarters does not have a decisive influence on its success. However, this is precisely what is implicitly assumed on the stock exchanges if you look at the valuation discrepancies between German and American companies with comparable products and business models and a similar regional positioning.

Valuation across the board has almost halved in the last 10 years

This was particularly reflected in the valuation of small and medium-sized companies. Due to the aforementioned general conditions, there has been extremely low investor interest over long periods of time and, at the same time, pressure to sell. These companies are also underrepresented in passive products, and as more and more capital is invested in passive products and flows out of active products, companies that are not in the top tier are also being sold, regardless of their actual value. At the same time, despite the recession in Germany, the companies' business was largely stable, in some cases sluggish, but also very good in others. In this respect, we see valuations that are often beyond good and evil and suggest a rather sad future. If you look at the share price performance alone, you don't immediately see that valuations have been falling for almost 10 years. This is due to the rising profits that most companies have achieved during this time. At the same time, the substance of the companies has regularly increased significantly since then due to the retained earnings. On today's basis, double-digit returns are theoretically almost the inevitable consequence in the future, given reasonably stable conditions. It should also be borne in mind that today's results are still being impacted by the lingering effects of the COVID pandemic and the turmoil caused by Russia's invasion of Ukraine, not to mention the soaring interest rates.

Valuation compression has various causes

What were the reasons why German (and other European) equities were neglected? We can only speculate.

Apart from the poor political performance in Europe, the easiest way to explain this of course would be to say that the bull market feeds the bull market and vice versa. Apple and the other American technology giants are worth more than the entire German stock market, so why bother going into detail. Irrespective of the valuation, admittedly, but this currently only plays a subordinate role in many investment strategies.

In addition, the global growth prospects have become rather weaker: Demographics, a more mature economy in China, more regulation, limitation due to the scarcities of natural resources, starting with the CO2 issue.

Excessive and sometimes senseless regulation is likely to play an important role

Then there is the excessive regulation: it also affects many investors in their own profession, especially in risk management, which often means that investments are assessed primarily in terms of their volatility and liquidity, but no longer on the basis of expected profitability, i.e. the valuation of an asset no longer plays the dominant role, if it plays a role at all. (See the willingness, not so long ago, to buy government bonds with a term of one hundred years and a yield of practically zero, mind you, under the watchful eye of the regulator). And with the neglect of valuation, the importance of the core parameters of an asset itself also dwindles, as this is all about assessing the prospects for success, quality and sustainability of a business model. Most companies were not founded with the main aim of generating low-volatility returns and enabling investors to join and leave the group of shareholders on a large scale at any time. We are right there with Milton Friedman: The business of business is doing business. And being profitable at the same time. However, the other parameters liquidity and low volatility are much better served by the bond market. This in turn explains why the change in preferences in this segment of the capital market has led to significant inflows and why there is generally not much activity in equities. And when there is, it is in the large stocks. The hunt for low-volatility investments in an uncertain and unstable world with company-like returns: This contrast offers arbitrage opportunities for specialists like Bernie Madoff.

German investors are letting international investors get the better of them

If you then consider how the stock market is viewed by the public in Germany, you can see another problem. The equity-based pension, which the current government had once planned to introduce, is being scrapped in view of the budget shortfalls, having previously been criticized as a form of gambling from many sides. The German Chancellor is proud of the fact that his savings are shrinking in real terms. The fact that the Quandt family collects dividends in the billions from their BMW shares every year is seen as a scandal and the like, instead of the critics coming up with the idea of buying a few BMW shares themselves and cashing in. In the USA, there have been 401 K plans for decades, which by and large correspond to stock pensions, as well as pension funds that are among the largest investors in the world. For firefighters and teachers, among others, while many teachers here would probably be horrified to become part of the gambling machine. As long as there is no family background, the majority of the largest German companies are owned by foreign investors, with ratios well above the 80% mark. You would have to imagine that in the USA.

Professional market participants are also shining in their attitude towards the companies they follow. While everything was painted in rosy colors at the time of the IPO, the outlook is suddenly rather gloomy after share price losses of 50-90%. The situation is split for established companies. There are companies that have benefited from the upheavals of recent years that are now suffering from the downside. The companies that have suffered, on the other hand, are benefiting from catch-up effects. Companies operating on the Internet were able to acquire new customers relatively easily, who can now spend their money differently again. Chemical and basic materials companies benefited from shortages and restricted supply chains and were therefore able to impose high prices, but today they are suffering from the loss of anticipated demand, higher interest rates and the reduction in inventories across the value chain. The same applies to DIY stores, for example, after "home improvement" was one of the activities that was not prohibited during the pandemic period. On the other hand, companies such as Lufthansa and TUI, as well as car manufacturers, are benefiting from the ongoing normalization, as pent-up demand has guaranteed good prices for more than a year. One could now assume that the current situation will settle down again. However, this is not the case: while it is assumed that the companies suffering from the normalization will hardly see any improvement, this is almost certainly the case for the current winners. There is no other explanation for the current valuations. In this respect, there is therefore no support from capital market participants.

Private equity funds conjure up volatility and therefore do not need liquidity

Private equity funds, on the other hand, are pure magic: here, the volatility of investments is conjured away by updating the purchase prices as long as the general conditions have not changed substantially. This means that there is no longer any need for liquidity, as there is no need to sell something that does not fluctuate in a panic. At the same time, nobody is interested in the fact that the risks are actually increasing significantly thanks to massive borrowing by the companies being "invested" in. And since at least reasonably successful companies have the ability to earn money over the years, the accumulated debt will regularly pay off. In this respect, these vehicles are also in a position to pay prices for companies that are well above the level that is usual on the stock market. And at the same time, nobody has to worry about the fees, which are significantly higher than what is usual for equity funds. In this respect, it is no wonder that this asset class has become increasingly popular in recent years, even if the rise in interest rates may have shaken up some funds.

As a result, the valuation differences between asset classes have grown massively in recent years. While it used to be common for equities to be valued at risk premiums of 3-4% over government bonds, this has long since ceased to be the case, apart from the heavyweights with a first-class business model. Today, these tend to be in the range of 7 to over 10%, without taking inflation protection into account in any way.

This leads to the remarkable discrepancies that can be observed everywhere. Just a few examples that are not necessarily represented in our funds, otherwise we could be accused of bias.

Substantial differences in the valuation of identical assets depending on ownership

And to all those who disagree with the current politics in Germany (according to surveys, two thirds of the population and perhaps some readers too): At the chemical company Lanxess, it is assumed that the joint venture founded in 2022 with a private equity company is actually bankrupt due to the usual level of debt there, that the catastrophic profitability of the chemicals business will not improve in the next few years thanks to record low capacity utilization and that a capital increase is therefore required that is higher than the current market value. It is questionable whether the private equity company has also written down the value of its stake in the joint venture to zero, as the market has done with Lanxess.

HelloFresh, a globally active internet-based food producer and retailer that has been extremely successful in recent years and operates with a sophisticated business model, is valued at 4.5 times last year's EBITDA, i.e. around €2 billion. Two years ago, the food delivery company Gorillas, known for its black-clad cyclists in some major German cities, was valued at a minimum of €3 billion in a private equity financing, without this business model being anything special. The company is now apparently bankrupt.

Software AG was taken over by an American financial investor last year. The offer was more than 50% higher than the previous share price. Six months later, the investor sells a division (you can calculate differently, but it is roughly estimated to be 50% of the group) and receives almost its entire purchase price back in return. Which, as I said, was 50% above the previous share price.

The free float of Telefonica Deutschland is being bought back by the Spanish parent company at 50% of the price of the IPO a good 10 years ago. Thanks to extensive dividends, which were more than covered by the free cash flow, the existing investor came out of the investment without a loss. Telefonica, on the other hand, can currently enjoy a free cash flow yield of 15 to 20%. The sellers can now invest their money in German government bonds at just under 2%, which is now considered attractive.

There are more examples, and probably even more a year from now.

What this will change is open, but ultimately irrelevant: Based on the valuation, there should be very solid returns

So far, so bad. The question remains as to why the situation should change now and what is needed to trigger a turnaround in investor interest. The only answer is that you usually only know afterwards. Valuation alone is not enough, but valuation is inevitably the decisive factor in the long term. With the appropriate horizon, i.e. more than two months, you can invest with a substantial margin of safety. And there are obviously already two groups of investors who are taking advantage of this opportunity. These are the companies themselves via their share buybacks, and financial investors.

After a long period of rejection of share buybacks in general, more and more companies are coming to the conclusion that their own shares are undervalued, right across the market. Most encouragingly, the reason for these buybacks is low valuation and not, as in the US, sufficient liquidity, regardless of valuation; or, worse still, pressure to compensate for dilution from share options issued, the value of which is regularly not taken into account when calculating earnings. An obstacle for smaller companies is often that not enough shares are traded on the stock exchange to implement the programs quickly. The situation is different for larger companies, where progress is also rapid. The total buyback volume is likely to be in the double-digit billion range. And every share bought back increases the stake held by the remaining shareholders, at a price that is currently quite favorable.

And the aforementioned financial investors. At the current level, we see these as more of a threat than an opportunity. Because unlike in the past, when they had to improve a lot operationally in order to achieve their target returns, today trivial financial engineering is sufficient to achieve substantial profits, see the example of Software AG. In this respect, there is a risk that equity investors will be ripped off, even with what at first glance appear to be attractive valuation premiums, if the majority of shareholders accept the investor's offer. Of course, it is still better than losing money, but after a long dry spell it is still not something you want, unlike an aggressive approach to share buybacks.

What is on offer in our funds and what can we expect here? What if everything were to return to more or less normal? Illustrated by some positions in the All Cap Fund:

A service provider that is the cost, quality and brand leader in its industry, with at least mid to high single-digit percentage growth and a P/E ratio of 10, with low required investments and a correspondingly high ability to pay dividends.

A raw materials company whose new site is one of the cost leaders in the industry and whose investment costs today would be higher than the valuation of the entire group, with the new site accounting for only a quarter of output.

A defense contractor whose order backlog exceeds the current year's sales by a factor of 5 and is accompanied by rising margins and which is valued at a single-digit P/E ratio on the basis of incoming orders despite high visibility.

Two banks that will distribute approx. 30% of their market capitalization in the next 2-3 years, fortunately in large part in the form of share buybacks at (today's) half book value, which will automatically cause it to rise further and should strengthen the substance at the same time.

Industrial companies, 50% of whose profits come from recurring services and spare parts and which, with a solid balance sheet, are nevertheless only valued at a P/E ratio of 5-6.

We also see plenty of opportunities in other stocks in which we are not currently invested. This provides additional reassurance that these valuation levels are a broad-based phenomenon and hopefully we have not fallen into the individual traps that look cheap but have a substantial underlying problem. On this basis, we are very confident that the coming years should be more encouraging than the last. Valuations have downside limits, and if they are set by investors who then buy the entire company. And current earnings do not require any growth, not even nominal growth, to justify the share prices. And nominal growth is very likely from the perspective of higher inflation rates alone.

Sincerely yours,

Martin Wirth

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FPM-Comment Reducing the Noise Martin Wirth: 4/2023 dated October 18th 2023


A recession is not the end of the world, but the usual course of events


  • The limits of macroeconomic analysis in investing
  • Recessions generally provide good buying opportunities for equities
  • Varying degrees of resilience to rising interest rates
  • Indications of favorable equity market valuations and a return to business as usual
  • Our kind of optimism or: Don't focus too much on the political environment when investing

The recession that has been smoldering in Germany for the past year, which began in the manufacturing sector, has now become apparent, but without having increased in severity. In the EU, the situation is not much better. In the USA and other regions of the world, the economy is also not particularly solid, but neither is it in recession.

The reasons for this are the slowdown in government transfers following the pandemic and the significant rise in interest rates, which are being used to combat the higher inflation rates caused by the previous increase in transfers and the war in Ukraine. For some economists who follow Modern Monetary Theory, it was surprising that printing money and increasing government debt do not create wealth. In the left-wing political camp (beyond the SPD center, just to clarify) obviously likewise, where printing and distributing money is known to be a core competence. In Germany, it was added that further economic procedures were to be abrogated in a hasty procedure, and the result can now be marveled at (or not, because it is not surprising).

The limits of macroeconomic analysis in investing

Just to make it clear: Economic aspects are not the core of our investment process. We simply use them to evaluate the environment and try to identify divergences between facts and opinions, just as we do at the equity level. Opinions or the perception of facts naturally influence sentiment and the willingness to invest, and thus explain a large part of the valuation fluctuations in the overall market. But each company has its own investment case, which often has nothing at all to do with the macroeconomic environment, but whose valuation is influenced by it. In this respect, an understanding of the general conditions is absolutely essential in order to be able to assess an investment and its valuation appropriately. One example is real estate stocks, which were driven by zero interest rates and have taken a disastrous turn with the normalization of the interest rate landscape. Although not quite as bad as the long-term bonds, after all, one is also invested here in real assets which, on the one hand, have always been able to generate rental income and whose nominal values have undoubtedly risen over time, unlike those of the bonds.

In addition, the assessments of the environment help to build a portfolio that takes into account uncorrelated or negatively correlated risks, which is particularly appealing if the resulting diversification can be obtained at a low price. Of course, it does no good (at least much less good) if you buy it too expensively. As examples: Banks benefit from rising interest rates, but most stocks do not. The same is true for commodity-related companies with respect to inflation, or defense companies to offset global crises. This diversification is not the main reason for an investment but can make a significant difference in the investment decision, all other things being equal.

What you also have to take into account when it comes to economic conclusions: Economists talk about the economy, but they have little idea what this means for stocks, since it is not their job to deal with this. It is therefore very dangerous to rely primarily on macroeconomic statements when making an investment decision. Otherwise, you run the risk of regularly exiting the markets at the bottom and re-entering them at the top. Recessions are times when it has historically been better to invest. If you want to get out of stocks, it is better to use boom phases to do so. Because a recession is not the end of the world, but simply the normal course of events. The mistake you can make is to ignore this normality. In addition, it should be taken into account that statements on the valuation of shares from a macroeconomic perspective regularly only apply to the level of the index, i.e. valuation differences between the individual market segments, let alone individual companies that are not taken into account at all, or are treated with the remark that the market is always right. Of course, this is nothing other than refusing to do the job. Because if the market is always right, why does it change its mind every day? If you then combine half-baked statements with so-called artificial intelligence, which regularly exhausts itself in trend-following models based on the latest revisions of results, then a lot becomes explainable. Where investors take a closer look, however, because decisions are more difficult to revise, is in private transactions, for example in the area of private equity investments. And here, valuations now deviate significantly upwards from what is being called on the stock markets. But all this is just a side note. Last remark: In almost 35 years in the industry, I have never seen an economist who was really optimistic. They have that in common with the bond market. Skepticism sounds smarter, but it doesn't make money.

So back to the topic: The economies have been deprived of monetary steroids, but things don't look so tight yet in terms of fiscal policy. Since Germany is once again a bit more prudent than most other countries, this is an additional burden on the national economy.

Recessions generally provide good buying opportunities for equities

All in all, this is not an easy situation, but it is also far from a disaster. This also explains the high stability of the stock markets that appears at first glance, but again, only at first glance. Beneath the surface, there have been some significant shifts. In particular, a number of highly capitalized stocks recorded a solid performance on the basis of a valuation that was previously at most reasonable and in some cases low, and a business that was by and large stable. The same applies to a whole range of mid- and small-cap stocks. Those who suffered significant price losses in some cases were not only cyclical stocks, as you might expect, but also, and in some cases to a much greater extent, companies previously traded with high growth expectations. The victims of rising interest rates lost, the profiteers gained, unsurprisingly. And all in all, as has been the case for years, the market moved sideways in a stable range, or, including dividends, slightly upward.

Varying degrees of resilience to rising interest rates

This is not self-evident insofar as interest rates have risen significantly worldwide for almost two years. Since their peak, the prices of U.S. government bonds with 10-year maturities have lost almost 50%!!! (in words: fifty percent). Investors in German Bunds have earned nothing in nominal terms for more than 10 years, not to mention real losses. Interest rates are the anchor on which all valuations are based. A few years ago, it was a horror fantasy that central banks would raise interest rates even in the 1-2% range. And now: not much is happening at all, across the board, and in aggregate, not even in equities. Which in our eyes is crystal clear evidence of the low valuation of equities, which in turn is evidence that this tectonic shift in interest rates had already been partially expected in equity prices. And shareholders, unlike bond investors, have not been fooled by central banks, especially that wealth could be created by printing money. This distinguishes them from bond investors, who are supposedly much smarter than the more simply structured stock investors.

Resilience to rising interest rates, however, does not apply to all sectors of the economy. There are, and will continue to be in the near future, enough headlines about companies and structures that have been swept off-course by rising interest rates, i.e., that are getting into substantial trouble because of the devaluation of their previously inflated assets or because their cash flows are insufficient to service their debts. First and foremost, of course, is real estate, but also investments in such things as renewable energy production parks, whose attractiveness was partly fed by the fact that the debt capital needed for the investment could be had almost interest-free. And further, there are no limits to the imagination here. However, one should not be deterred from not entering into attractive investments: For everyone who has to pay higher interest, there is someone who receives higher interest, to that extent this is primarily a redistribution issue, and geniuses who were just celebrated now look quite out of place. As Mr. Buffett once said, "Only when the tide goes out do you discover who's been swimming naked." But most of them are swimming in their trunks (and swimsuits, to be gender correct): For the vast majority of those who are solidly financed, the calculation is that higher interest rates will be compensated for by higher inflation rates. As a result, there are likely to be jolts here and there, and the result is the slight recession described above, which has been ongoing for more than a year. And there is no clear improvement in sight for the time being: The effects of higher interest rates will become apparent gradually over a longer period of time. If you adjust to this, the surprise will be less unpleasant. However, one thing should also be noted: If a normal company gives up an investment because interest rates have risen from perhaps 1% to 4% or 5%, then the investment was not a terrific one to begin with, and the business model was not exactly convincing.

Doubtful motives for bond buyers

Despite the poor performance of recent years, the outlook for bonds is likely to remain modest going forward, except for some interim relief. There will continue to be no, or at most low, real returns. This is quite different from equities, even if this will not always be immediately reflected in share prices: Companies whose business model is only rudimentarily any good will pass on their cost increases to customers, at least in part. Ultimately, this is where inflation comes from. Even if it is clear that labor will become relatively more expensive in the Western countries due to demographic factors: The losers are not primarily the companies, but the savers in nominal investments.

In practice, of course, there are still reasons to buy bonds instead of shares. Two groups of buyers have to be distinguished:

  • Some don't know what they are doing, because 3% interest with 3% inflation is a guaranteed capital loss after taxes, or:
  • If, for example, regulatory requirements demand a return of 3%, then you can just buy bonds and have done your job and can go home early. Whether the customers consequently lose money is irrelevant, because from the formal perspective, everything is fine.

Or there is a future in which inflation rates fall back to zero (where, properly calculated, they never were), which would be quite astonishing, to say the least, in view of the financial policies visible around the world. In a world where the media hype people like Bankman Fried, the former crypto billionaire and current defendant (to name just one case, Markus Braun of wirecard should not be left out either), one should not be under too many illusions about the precision of the analysis of many participants in the financial markets. At the end of the day, we should thank those who so generously support the economy with their savings, which ultimately also benefits the shareholders.

Indications of favorable equity market valuations

So back to equities. How can it be proven that valuations are currently low? For one thing, the formal metrics, such as P/E ratios or dividend yields. Both earnings and dividends can change quickly. A more sustainable metric is the price-to-book ratio or, in absolute terms, enterprise value. Here we are seeing record lows in series, the kind of lows that are only reached during recessions. Which is understandable, since we are in one. And buying in recessions has rarely been a mistake in the past. It should also be noted that the dispersion in valuations remains very large, and the figures aggregated at the index level look nowhere near as spectacular as already indicated. If the usual patterns hold going forward and the end of the world is not imminent, then there may be substantial opportunities here. Those who do not trust all these figures may find reassurance in two other aspects.    Firstly, German companies are buying back shares on a scale that was not even remotely expected a few years ago, provided they are not trying to protect their cash flows. This includes many companies in which families are major shareholders, who are therefore (hopefully) not primarily thinking about share price maintenance or compensation for distributed stock options. Furthermore, it is striking that insiders have been almost exclusively on the buying side of the reported transactions for months. There are different reasons why people sell a stock, but really only one reason why they buy. And that is with one's own money.

Why this might be a good idea can be illustrated using various examples which show that we are already well advanced in terms of economic weakness and that the drop-off should now be comparatively low. For example, global auto production is more than 10% below its peak in 2016/2017, which has not prevented German manufacturers from achieving record results. Chemical production, which is generally quite stable, is 20% below the average of the last 15 years in Germany, which is probably more towards the lower end of expectations despite the very high energy prices and is primarily due to destocking rather than high costs. This extends from logistics to retail, where the current business situation after the pandemic boom is pretty lukewarm. By contrast, the service industry looks quite encouraging, so the record results achieved here in some cases are probably not sustainable. However, no one seems to believe this when looking at the current valuations. Conversely, the same does not seem to apply to the depressed results of the manufacturing companies.

Return to business as usual

The recent much more pronounced fluctuations in the economy are due to the two major events of recent years, the pandemic and the war in Ukraine. Initially, money could only be spent on goods and no longer on services; the states distributed money that had not been earned and was now encountering reduced supply, combined with shortages in the logistics chain, which in turn led to precautionary excessive stockpiling, accompanied by the low interest rates of the central banks, all of which in sum led to significant price increases. Now, for the past year, the movement has been in the other direction, including exaggerations: Windfall profits are disappearing, wages are rising and putting pressure on margins, logistics are functioning more normally again, so there is also less need for increased inventories, and instead these are being reduced, ultimately also driven by the increased interest rates, because all of a sudden inventory financing is also costing money again.

These deviations from equilibrium will level off again, as these fluctuations are far from reflecting largely stable final demand. At the same time, companies are taking advantage of the current weakness in demand to improve their cost situation. It should also be borne in mind that falling prices for industrial products are squeezing margins, insofar as more expensive purchased products are gradually processed while the end products have already arrived at a reduced price level. However, the oil price, which is rising again, indicates that there is already a countermovement at this level and that the pressure on margins will disappear in the foreseeable future or even turn into the opposite. The same applies to the reduction of inventories, which will obviously be completed in the next few months. So everything is actually business as usual, if one disregards the size and sharpness as well as the shortness of the amplitude.

Our kind of optimism or: Don't focus too much on the political environment when investing

Anyone still waiting for a drama has spent the last few years in a deep sleep. Pandemic, war in Europe, energy crisis and, most recently, an explosion in interest rates: the global economy has come through all this with difficulty, but by and large successfully. It is likely that future growth rates will be lower than in the past. The only thing is: growth is practically not priced into current prices, nominal stagnation at best is expected for most sectors, long-term moribundity for many industries, and ultimately the disappearance of most companies. It is also the case that European policy-makers, and German policy-makers in particular, have an extremely poor understanding of economic interrelationships. Not to mention the psychological component, which, according to Ludwig Erhard, accounts for 50% of the economy, but then he was a professional. However, in the end, economic realities regularly dominate the ideologically driven wishes of politicians, ranging from Agenda 2010 to the continued operation of coal-fired power plants that are not completely climate-neutral, and once this is not the case, in many cases there is the possibility of avoiding the whole thing and, for example, gradually relocating one's production. Either way, however, we are talking here about a small part of the entire national economy that is structurally at risk, and should something actually be sustainably economically destroyed at some point: This is almost always already priced into the shares several times over.

We therefore continue to see the opportunities as significantly greater than the risks, provided that the overvalued part of the stock market is avoided. Many valuations are at long-term record lows, so the difficult conditions are probably reflected here in excess. And to all those who disagree with current politics in Germany (two-thirds of the population according to surveys, and perhaps some readers as well): One should never make the mistake of basing his investment decision on his political attitude as long as the society system is the same.

Sincerely yours,

Martin Wirth

FPM-Comment Reducing the Noise by Martin Wirth: 2/2023 dated April 19th 2023

Where does the road lead once shortages and crises are overcome?


  • Defying inflation with stocks
  • Our thoughts on inflation, interest rates and valuations
  • A look at America
  • Banks in the focus of negative scenarios
  • European banks are better than their reputation!
  • What does the market offer?

In the first quarter of 2023, the previous year's losses on the German stock market were partially offset. In this context, large-cap stocks fared more favorably than small and mid-cap stocks, which had to make up for higher losses. In general, however, the development was not compelling at first glance given the news situation.

The war in Ukraine continues, geopolitical uncertainties have not abated, inflation seems to be getting out of hand, and at the same time more and more signs of economic weakness are emerging, with the U.S. leading the way. Accordingly, many sentiment indicators are at low levels, so the development took place without much enthusiasm from market participants.

Defying inflation with stocks

On the other hand, and from our point of view as value investors, this was the decisive factor: equities are generally valued lower than they have been for a long time - not all of them, but a great many. And while companies across the board have been able to pass on cost increases to customers and thus keep the real damage from increased inflation in check, this has not been possible with nominal investments as well as with investments in real estate. Given the general conditions, it is no wonder that enthusiasm is not overflowing, quite the contrary. However, you might also ask yourself when you want to invest at all: You can buy lots of companies at a more or less significant discount to their net asset value, even if you don't believe in the sustainability of their current profits.

We certainly agree on the latter. Fortunately, the shortages created by the pandemic and later the energy crisis are finite. To that extent, excess returns will disappear again, starting with freight rates, energy prices, car prices and the like. Only: Who believed that this could go on forever? Even if the earnings estimates were still based on an extrapolation, the valuations of the companies showed that no one really dared to believe this.

The exciting question now is whether the focus will return to companies with a stable business development that is rather independent of the economic cycle, but which still tend to be fully paid, or whether people will accept cutbacks in business quality and go on the great bargain hunt. Since the market obviously prefers to look at the trend in profits rather than what one has to pay for them, one could tend toward the first thesis. However, this market area is now much smaller than in previous years, after some former high flyers in particular were massively punished. In this respect, the distinction today is somewhat different than it was in the last few years. Favorites could rather be those companies which are considered boring, reasonably valued, which do not arouse much imagination, but which are also not substantially undervalued and in the best case free of scandals. And on the other hand, likewise solid companies, but whose earnings power can fluctuate significantly within a few quarters and for which investors fear price losses under these circumstances. In short, on the stock market 1+1+1 is worth more than 2+0+2. This means that investors would rather forego earnings in exchange for peace of mind.

Our investments cover both of these categories, with a bias towards low valuations. On the other hand, we continue to be uninvested in top quality (at least companies perceived as such) for valuation reasons.

Our thoughts on inflation, interest rates and valuations

What drives us? In addition to looking at the sustainable earnings strength of a company, which is precisely not reflected by quarterly results that fluctuate more or less in the short term, one cannot neglect the influence of the permanently changing underlying conditions. Since the Covid crisis, these fluctuations have reached dimensions previously unknown. Therefore, they also have an impact on our investment decisions, and hence now our view of things (which may or may not be shared).

First, inflation: it is obvious in our eyes that the peak has been clearly passed, that inflation is on the retreat, and that these developments will run through the entire value chain. The laggards are collective bargaining, which will ultimately cost companies money, which is obviously already factored into the markets' implicit expectations. After inflation rates roll over they will probably fall significantly in the course of this year and the next. However, no one can seriously claim that there will be a comparatively narrow corridor as felt in recent years. And it is more than likely that inflation rates will remain in a range that is too high for central banks for longer, at least if you want to follow their statements.

This has implications for the valuation of companies that are dependent on the level of interest rates, first and foremost real estate companies in the negative sense, banks and insurance companies in the positive sense. This also applies to companies where, for example, retirement provisioning has been inflated in recent years. Here, one should not assume that the old interest rate levels will be reached again, especially not after the unpleasant experiences with regard to the distribution effects of inflation, which can be read in any textbook on basic economics, but which were obviously not really appreciated as reading in the decisive places.

This will therefore lead to an increasingly restrictive monetary policy for the next few quarters after the damage done has to be compensated. However, and we are probably in the majority camp here, monetary policy will tend to loosen again as soon as possible albeit not to the same extent as in recent years and not before next year.

Until then, in addition to the slowdown that is underway anyway, the fading of the post-Covid boom and the decline in scarcity prices will be headwinds for companies. In Europe, at least the absence of the Armageddon of the energy crisis has created a slight additional tailwind that may help avoid recession. The distortions were already partly borne last year, as can be seen from the full stop in the chemical industry, so that the height of the fall has been significantly reduced. And what was calculated at the time has turned out to be far too pessimistic from today's perspective. The rise in gas prices, for example, is costing Germany less than 0.5 % of national income compared with the lows of a few years ago, which is so little that policymakers are not even seriously considering Germany's natural gas reserves, which would cover most of the country's gas needs until the “energy turnaround” is finally complete.

A look at America

Instead, things are looking less encouraging in the USA this time around. This, too, is more of a disillusionment that follows excessive monetary policy and the issuing of helicopter money to citizens. In the U.S., too, the wisdoms of economics are only gladly followed if they are politically communicable, i.e., if they please the citizen. And at some point, this comes to an end. But here, too, it is relatively simple: Once the excesses have been reduced, things move on. And the excesses this time were very manageable compared to the times of the financial crisis: Only a few percent of national income given away, instead of several years of redistribution like before the housing and banking crisis. In this respect the world should look more "normal" again in a year's time: Employees will be easier to find, the economy will get used to the nominally higher interest rates, which are not high at all in real terms, and companies will have adapted to the changed conditions in their markets. Anyone who still does not believe that this is possible within a reasonable period of time has not drawn any conclusions at all from the extreme conditions of recent years.

Banks in the focus of negative scenarios

If all this seems plausible, which it just should after the experiences of the last decades, there still remains a wild card for the bears (besides war, geo-crisis, climate change, a comet impact):

Candidates for a new Armageddon are once again the banks. The following can be said about this without giving the final guarantee: the comparison with the financial crisis of 2008 is completely absurd, and this is particularly true for European banks. (Some) banks are suffering from an unwillingness to adapt to the changed environment and were ultimately poorly managed. The sooner this brought a bank to the brink of ruin the better in hindsight. UBS from 2008 or Deutsche Bank from 2017 are just examples of how business models were transformed when things could no longer go on and the neglect of business practices was no longer tolerated. The last one to bite is the dog, and in this case it was Credit Suisse, which after all managed to slide into ruin in a very short time as a solvent bank with weak earnings but without huge operating losses. Cause: complete loss of confidence. If Volkswagen no longer gets any steel delivered or Aldi no longer gets any food, then these companies will also go under. The only difference is that the trust there does not vanish into thin air in the shortest possible time. A terrific lesson for all other market participants. And bad luck for Credit Suisse, which had previously been the one-eyed man among the blind. Life punishes those who come too late (Gorbachev).

The following is all I have to say about the U.S. banking crisis: What was handled there as a business by some banks, which for unclear reasons are no longer subject to proper regulation, is not intended to be so according to Fundamentals of Banking Management Part 1: Investing short term deposits in long term government bonds and hoping that the different yields will bring the big payoff. Until the next inversion of the yield curve. For once, some good news: In Europe, this is no longer conceivable at this level.

What is conceivable or even a fact is that investors in government bonds lost a lot of money last year. The amount that was a burden on banks' balance sheets at the peak was more than € 600 billion. A lot of money, but only a fraction of the equity. In the meantime, it has fallen again significantly as a burden, especially in the U.S. and the U.S. dollar. This has not stopped depositors from withdrawing their money, essentially unsecured deposits, from Silicon Valley Bank, since the benefits and returns of holding deposits with an insolvent bank are completely asymmetrically distributed: There is no additional benefit compared to an account held at a stable bank. In the case of other banks these burdens from the rise in interest rates were much lower or were refinanced on time. In this respect this is on the one hand an individual problem. On the other hand, however, and this is much more relevant, this has nothing whatsoever to do with a financial crisis like the one in 2008. It is rather another consequence of the misguided central bank policy of recent years, albeit a consequence that does not lead to insolvency, but could essentially cost some banks a portion of their earnings - or has already done so.

European banks are better than their reputation!

From our perspective, the situation is actually the exact opposite of what is served up in the media: Thanks to years of pressure from regulation, additional charges and low interest rates, banks are perceived as notoriously low-yielding. In many ways, we are at a tipping point here and have probably already passed it. Roughly outlined: Regulation will obviously no longer be tightened significantly, bank levies (nonsensically not even deductible for tax purposes in Germany) will fall, and most importantly, the normalization of interest rates will make normal banking profitable again, on both the deposit and the asset side. Unlike in 2008, it is obvious that banks have a clue what they have on the balance sheet and are documenting it. Unlike their supposed observers, who fabulate wildly about risks without even once taking note of simple facts. Events such as the demise of Credit Suisse undoubtedly weigh on sentiment and the willingness to invest in the sector. But it should also be certain that other banks will benefit from this unraveling. The demise of Credit Suisse was ultimately the result of a decade in which the bank earned nothing, unlike its employees. If this serves as a blueprint for how not to do it, then there is something good about it. Consolidation has never hurt any industry, and it will be no different here.

What does the market offer?

Short-term uncertainty, high but falling inflation rates, a weakening economy with the potential for recession, at least in parts of the economy, are the framework for the coming months. At the same time, sentiment and valuations are where one might expect them to be in a recession, as opposed to still current earnings expectations.

Shares of even rock-solid companies are now trading at significant discounts to their substance in many cases, to the extent that the recession has just been priced in and the earnings power that can then be expected is seen as permanent. At the same time, dividend yields are at record levels. This is not necessarily a reason for many investors; as is well known, dividends can also be cut or cancelled. What is more relevant however is that ratios such as dividend yields in relation to P/E ratios are at levels that were only surpassed during the global financial crisis and the pandemic crisis.

More and more companies are starting share buybacks due to sustained low valuations, which in recent years have often been seen as a bankruptcy of entrepreneurial idea creation. In this respect, there is obviously a point at which one cannot resist after all. From a mathematical point of view, all this is quite easy to understand.

Without going into details: Many companies have valuations according to a wide variety of criteria that price in completely different, and indeed worse, underlying conditions than are likely from today's perspective even if one does not want to regard the current earnings estimates as a sustainable basis. In our view the reason for this is that in recent years many investors have simply capitulated to the volatility of the stock markets and preferred to retreat to nominally stable investments. Additional regulation, but also trading according to more or less trivial algorithms instead of the most comprehensive understanding possible of the complexity of the economy, may have exacerbated the volatility ...

The fact that private equity investors pay twice as high valuations for the same investments as those demanded on the stock market ultimately only makes sense if they can procure the capital much more cheaply than is the case on the stock market. As long as interest rates were low, these investments could be sorted into the range of volatility-free investments by the financial investors, which was then also useful for risk assessment. Pure accounting that has nothing to do with economic reality. This was similar with bonds and especially with real estate. Here, too, one can see the differences between the fungible (stock market) and non-fungible markets: While transactions with real estate are carried out at significant but understandable discounts (10-15% are regularly quoted) to the former peak prices, real estate stocks were literally slaughtered.   Price losses of more than 70 %, which would represent a discount on the debt-free calculated real estate of 40 %, with simultaneously rising construction and replacement costs: this is largely senseless. And not to mention the many "unicorns" that are practically turnover-free but valued in the billions: The great returns have then often only been on paper, but presumably properly audited. Here, too, things have obviously changed.

The turnaround in interest rates has probably hit like a fox in a henhouse. Obviously, it's not just the generally subdued mood that's getting to investors. By all accounts, the interest rate turnaround is also an issue that has damaged the solvency of many investors. In this respect, it is clear that risk appetite is reduced for the time being. And this, unlike recession fears, is what we see as the main reason for the modest valuations and, in our view, obvious large investment opportunities.

What appears positive in this light is the fact that many companies, while not among the darlings of the investment community in recent years, have performed stably to decently in this difficult environment. Share buybacks have already been mentioned, but obviously there are also valuation levels at which, interest rates or recession aside, people no longer want to part with investments. And prefer to wait until the smoke clears. If there are setbacks buyers will quickly come out of hiding as long as the valuations are not excessive. In this respect, we believe that there is a lot to be said for the fact that we are somewhere in the area of the bottom for many stocks. And that these stocks will perform when things develop the way they always do: slowly forward.

Sincerely yours,

Ihr Martin Wirth

Martin Wirth

Founder and member of the Board

Experience in German equities: Since 1990

Responsibilities: Fund management, equity analysis and corporate management

Funds: FPM Funds Stockpicker Germany All Cap mutual fund
Institutional special mandate for a single family office

Awards: Numerous awards for the funds managed by him, also multiple personal awards from Sauren Fonds-Research AG, Citywire and others


  • Portfolio manager at Credit Suisse (Deutschland) AG
  • Equity analyst at Bank Julius Bär (Deutschland) AG
  • Equity analyst at Credit Suisse First Boston

Graduate in business administration from the University of Cologne (Dipl.-Kaufmann)

Raik Hoffmann, CFA

Member of the Board

Experience in German equities: Since 1997

Responsibilities: Fund management, equity analysis and corporate management

Funds: FPM Funds Stockpicker Germany Small/Mid Cap & FPM Funds Ladon mutual funds


  • 15 years at DWS Investment GmbH – managing the DWS German Small/Mid Cap fund, as a member of the European small/mid cap team of DWS and the DWS macroeconomics team and responsible for risk scenarios

Graduate in business administration from the University of Leipzig (Dipl.-Kaufmann)