We recently heard Larry Fink specifying the interest of investors in moving towards quality/safe haven and in particular towards bitcoin. Is this really the case? What do we mean by safe haven or protection? This is where we will look at all of these elements together.
What does the search for quality/safe haven mean?
Generally speaking, a transfer to a safe haven highlights the behavior of investors who want to protect their capital during an economic slowdown (more volatile period) or a more complicated situation at the geopolitical level. This can be done in several forms depending on the context. As it seems that the demand for bitcoin is increasing just as much as that for gold in the face of the Israeli conflict and global terrorism according to Larry Fink (CEO of Blackrock), we are going to take a closer look at this. Before going into more detail, we will look together at the different forms of protection, search for quality and safe haven.
Principle of safe haven through companies
The search for quality can be done at any time for investors looking for financial stability. It can be all the more important in a context where the economy is fragile and geopolitical problems persist. Quality represents companies that have proven themselves under different circumstances. That is to say those who have gone through crises like 2008 or 2020.
For companies, we look for companies with stable growth, stable and positive profits, a good debt ratio as well as liquidity to meet its responsibilities. Basically, we are looking for financial stability and profitability.
Safe haven principle across major asset classes
We have several major asset classes. Let’s give a quick reminder of all asset classes:
- raw materials
- bond market
- Money Market
When investors become more skeptical about the economic environment, they will adjust their portfolio accordingly.
As a general rule, the search for safe haven can result in a transfer either to the bond market or the money market. The bond market represents bond securities issued by the State with maturities greater than one year. The money market will issue treasury bonds which represent shorter maturities (less than one year in general).
Over the last two years, government bonds have lost their protective role due to inflation, the number one enemy of this type of asset. That said, it was rather the securities offered on the money market which served as protection and transfer to the safe haven. As central banks have increased policy rates and money market rates are closer to that of the central bank, the rates offered have become attractive and risk-free. For example, we are talking here about treasury bonds which can offer 5% return without risk. We can also see in the graph below the enthusiasm for the money market with the evolution of flows on the money market.
Government bonds will regain a certain popularity when the rates offered on the bond market are just as attractive as those offered on the money market. All with a parallel focus on the slowdown in economic growth as well as inflation. This is why bonds tend to outperform in a recession environment compared to stocks. Here is an example in the table below:
The context is decisive for a transfer towards quality
To understand why there may be a shift towards quality, we need to understand what pushes investors to move towards quality. In general, it is more the economic or geopolitical context. We seek to reduce risk and protect ourselves as much as possible from volatility. When we have an economic slowdown, there can be more volatility in the markets and particularly in more risk-sensitive securities. Therefore, it is important to understand that not everyone remains comfortable with volatility. On the other hand, a slowdown in economic growth is not always followed by a recession but it is what can precede a recession. Here is an example of an economic downturn as well as the performance of the S&P 500. It can be seen that the movements can have larger upward and downward fluctuations at the same time.
In this type of economic slowdown context and depending on the level of inflation, either cash or bonds can perform.
In another register and in other contexts, we can also talk about bitcoin and gold. Especially in the context of protecting against hyperinflation or geopolitical problems like war. So be careful, it is not cryptocurrency in general that serves as a safe haven but rather its leader, bitcoin, since it is the one that has been the most popularized, and especially the one that has gradually proven itself.
Gold or bitcoin, which should we favor?
Either way, gold and bitcoin remain two assets that demonstrate resilience through geopolitical issues like wars or hyperinflation issues. In the long term, these two assets have one thing in common, they remain a struggle against the devaluation of the fiat currency. Money being the currency issued by central banks. Since there is no limit to money printing, they can show protection. For what ? Both gold and bitcoin have a limited supply. Consequently, this allows them to gain value against fiat currency in the long term.
As gold has more history than bitcoin, it can be said that it has been quite resilient during stock market crashes in the past. Compared to stock market indices, it has been quite rare to have a negative 2-digit performance during recessions. Here is a table that highlights this study:
For now, we don’t yet have enough history on bitcoin to justify that it is resilient enough through multiple recessions. For what ? It has only experienced one recession, the one triggered by COVID-19. This recession was immediately rescued by a massive injection of liquidity. Therefore, bitcoin rebounded very quickly because it likes liquidity. When liquidity is injected, it increases the monetary supply, and since bitcoin has a limited supply, this is positive for it. However, during the Covid crash, bitcoin fell in line with stock indices.
Choosing the timing for gold and bitcoin
Generally speaking, both have similar advantages, particularly in the face of fiat currency, limited supply and geopolitical problems. That said, one is more resilient during recessions because it has less volatility. As a result, gold tends to outperform bitcoin during economic downturns. And from another angle, bitcoin tends to outperform gold during economic growth accelerations. Here is the GOLD/BTCUSD ratio which highlights these variations. The rectangle represents periods of slowdown and the arrows represent periods of growth acceleration.
The choice depends on the reason for protection
Everything will depend on the meaning we give to the term quality. Whether it is to combat fiat currency, protect against hyperinflation or geopolitical issues, bitcoin and gold can be a transfer to quality.
When it comes to stocks, a move toward quality would be similar to saying you want a company with financial stability. That is to say that we take into account the notions of solvency, liquidity and profitability. We can add to this companies that have stood out for a strong competitive position in their industry for several years.
On the other hand, during periods of economic slowdown with high inflation, we will prioritize cash which can be attractive (high remuneration without risk). And still during an economic slowdown with low inflation this time, bonds will be favored.
The transfer to the quality or art of protecting oneself can be done in several ways. We have a wide choice of protection/quality which remains available. This choice will depend both on the reason and especially on the context for which we want to protect ourselves.
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