Life beyond the eurozone

While Europe’s non-eurozone equity markets provided a safe-haven during the worst of the currency union crisis, recovery in the eurozone is forcing an adjustment in expectations and valuations.

As the eurozone grappled with the debt crisis and faced huge instability because of the threat of defaults that swept back and forth across southern economies, the European equity markets in countries outside the currency
union benefitted.

Most of them, most notably the UK, were not without debt funding issues of their own, but they were seen as relative safe havens for many European funds needing to take a defensive stance as they tried to ride out the storms.

This has come at a price: “There has been a premium paid for the relative safety of the non-euro markets,” says Hugh Cuthbert, manager of the SVM Continental Europe Fund.

As the eurozone has stabilised and the recovery started to take root so its equity markets have picked up and experienced a rapid uplift, leaving some of the non-euro markets looking overvalued and sluggish by comparison.

That has prompted managers to take a more cautious and selective approach, although many are confident that the economic indicators support continued commitment to the non-euro markets, and that value and growth potential can be teased out.

STOCKMARKET DISCONNECT
“Everybody has had a very depressed view of Europe because of the poor performance over the eurozone,” says Kevin Lilley, manager of the Old Mutual European Equity fund.

“It is starting to recover and we should see growth in those markets later this year but some of the peripheral markets are really starting to outperform. We are looking at 2.7% GDP growth in the UK this year compared to only 1.2% across the eurozone.

“The forecasts for Switzerland, Sweden and Norway are also running at 2% or more”.

He cautioned against getting too focused on economic performance, however: “The economy in those markets might grow strongly but that isn’t always reflected in the stockmarkets”.

Concern about this disconnect between economic performance and equity values has also been felt at Allianz Global Investors: “Last year was very much about the hope of recovery in earnings. This has to be about delivery,” adds Marcus Morris-Eyton, portfolio manager associate for AGI’s European Equity Growth.

“There has been some feed through from economic recovery to corporate
recovery but it is taking much longer than you traditionally expect”.

Cuthbert is also nervous about the optimism of recovery. “There is a danger that the markets are discounting the future newsflow. They have already moved on the assumption that things have troughed out and are going to get better.

“All the indications are that they will but that is not written in stone. It has to happen and markets will look expensive if it doesn’t,” he says.

The flight to safety has not just been about debt and economic conditions. It also reflects the ability of countries outside the euro to use their currency to support their markets and manage the external pressures in a way that
countries within the euro cannot.

“Beyond the obvious benefit of diversification, another benefit of investing in equities in the non-eurozone markets is that those economies can adjust faster due to normal currency adjustment,” says Krill Ganin, head of investment services at Oracle Capital Group.

“It is about how the euro moves in relation to other currencies,” adds Juliet Cohn, a senior portfolio manager specialising in European equities at Principal Global Investors.

“Non-euro countries can manage their currency to suit their market conditions. It acts as a safety valve”.

Most of the non-euro currencies are slipping against the single currency, but this is “more about a stronger euro than any weakness and devaluation on the part of the other currencies” says Max Anderl, head of Concentrated
Alpha Equity at UBS.

This recovery in the eurozone, while benefitting eurozone equity markets also presents an upside for firms in the non-euro markets, adds Anderl: “The closeness to the eurozone has been a disadvantage recently but it is now an advantage as those markets have strong trading links
with the eurozone and strong exports”.

ABOUT THE AUTHOR
Viola Caon
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