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The high price of safety

04 October 2019

 Salomons Judgement

Equity investors prefer safety above all else. They invest with cowardice. The summer of 2019 may go down in history as the bubble in risk aversion.
Everyone who has savings, a mortgage or bonds knows that the interest rates are ridiculously low. Investors are willing to pay interest to keep their money safe with the government. The same phenomenon can be perceived in the equity markets. These markets have had some excellent years. The American equity market is even close to the records that were achieved in July this year. Yet investors want safety above all else. Safe shares are therefore ridiculously expensive.

Let’s take the safe Nestlé share as an example. The food group is worth more than BMW, BASF, Ahold, ING, Easyjet and Nokia combined. What do you get for an amount of about 300 billion euros in market value? In comparison with the basket of shares that I just mentioned, at least less book value, profit and dividend. The historical profit growth over several years is identical, but has shown far fewer fluctuations at Nestlé. In other words, as an investor you pay a premium for stability in profit development.

In times of low interest rates and great uncertainty about political and economic developments, I can understand that investors value stability. The question is whether this is the right strategy for the future. After all, you pay a lot of money and have limited upside potential. 

It’s very easy to understand why defensive equities have done so well. But the difference in valuations is extreme compared to equities that are more sensitive to the development of the economy. The cyclical companies I compare Nestlé to are just examples and no form of advice. Analysts may be wrong, but they expect comparable profit growth for the year to come. For a fraction of the price.
I know that you should never use valuations to time markets. They can always get more extreme. Moreover, we haven’t reached the end of this bizarre interest rate climate yet. What I do know is that extremes are not sustainable in the long term. Read the disclaimer on historic returns again before you choose safety. Risk aversion is currently the biggest bubble.

The author

Roelof Salomons

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