Henderson’s Tim Stevenson ponders whether improvements in European markets are sustainable
Tim Stevenson, manager of the Henderson Horizon Pan European Equity Fund, says a rotation out of bonds may be required to sustain the recovery in European equity.
There has been a remarkable swing in sentiment on European shares, which have recouped a fair amount of the previous underperformance against the US market and also against bonds. I am sure many are asking whether this trend can continue – so here is my view as a European fund manager.
I will restrict my comments to Europe – with the one exception that the excellent weekly publication ‘The Economist’ made recently regarding the USA turning European. The point is that the USA is now having to face up to the same issues about debt levels as the Europeans have been wrestling with for the last five years, and the postponement of the fiscal cliff/debt ceiling debate by two months means the issue will be topical again very soon.
But in the meantime, there is clear evidence that European economies have at least stopped getting worse, and may perhaps begin to look a little better later in 2013.
During Mario Draghi’s most recent press conference he pointed to a number of positive developments; namely, “Bond yields and countries’ credit default swaps (CDSs) are much lower, stock markets have increased and volatility is at an historic low”. He went on to highlight some of the lesser known improvements – “We are seeing strong capital inflows to the euro area. The deposits in periphery banks have gone up. TARGET2 balances have gone down. The size of the European Central Bank’s balance sheet, which is often considered as a source of risk, continues to shrink. So, all in all, we have signs that fragmentation is being gradually repaired.”
The picture is still far from euphoric however, with greater stability yet to filter through to the real economy – unemployment is still high and with growth likely to remain low, debt reduction will take years to achieve. The recent small improvement in sentiment indicators could lead to a self-fuelling virtuous circle of better growth as companies utilise some of the large cash piles they have available, and take advantage of historically low funding rates. An example of this is SAP – whose management looks like it will announce a good order book for their new systems as companies realise they need the best software to operate most effectively. Recent stimulus plans by China and Japan also show that Asia may trigger better growth. So, all in all, I think we can be reasonably confident at this early stage that global growth will be slightly better in 2013 than it has been in previous years.
This means that earnings should be able to make a small advance in most European companies this year. So while the performance of last year was totally due to the excessively over sold and cheap level of European equities (as we discussed many times with mostly sceptical clients), this year should see markets progress due to better earnings. Any further expansion of ratings of European markets would need a quite enthusiastic switch away from more expensive areas such as the US equity market. More likely is that we will see a switch from bonds – where the large flow of money in recent years has resulted in a number of ‘bubble’ characteristics. We have maintained for over a year now that in the view of us European equity managers, many European bonds look way too expensive, and that a switch from bonds to equities was justified.