F&C Investments: Fear, Panic and Reality ahead of AQR

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David Moss, manager of the F&C European Equity fund provides an update on European equity markets and his outlook ahead of the results of the ECB’s asset quality review (AQR).

Review of recent European market events

“As share prices slide, we are confronted by negative confirmatory bias everywhere we look. As investors in European equity we have lots of exposure to market crashes/ collapses/corrections, for example:

  • In 2000 market prices had lost touch with reality and, more importantly, with profits.
  • In 2008 growth was illusory, fuelled by ballooning sovereign and consumer debt levels, compounded by excess capacity in construction markets.
  • In 2011 the very fabric of the EU and the single currency zone came into question and we saw sovereign spreads move out to unsustainable levels.

“But valuations normalised after the TMT bubble, fiscally irresponsible behaviour prior to 2008 has been replaced with loose monetary policy and tighter fiscal policy and the sovereign crisis of 2011 was met by unprecedented liquidity injections around the globe. Market multiples in Europe are hardly worse than fair value and we think the market looks pretty good value, against any long term metric of asset value or earnings power.

“European stocks are suffering from a weak demand environment which is resulting in an absence of earnings growth. European PMIs have rolled over, as has consumer confidence, and inflation remains stubbornly low. And it can’t be ignored that tapering in the US presents a challenge for global liquidity conditions. However, there are opportunities for longer term investors. Cash returns to shareholders in European stocks are among the best in the world. Compared to fixed income, equity income is as cheap as it has ever been, and the equity yields are backed by substantial corporate cash balances. Euro strength, a significant headwind for European exporters in the early part of the year, has turned into euro weakness and a tailwind likely to turn earnings downgrades into earnings upgrades.

Looking ahead to the ECB Asset Quality Review (AQR)

“On Sunday the 26th of October we will learn the results of the ECBs asset quality review and by December we will see the implementation and results of the second tranche of the targeted LTROs. At worst bank capital will need strengthening, At best a hurdle to banks increasing their lending activities will be removed and the green shoots of easing credit demand will translate into meaningful demand in the real economy.

“We don’t know if growth will come back to Europe in the fourth quarter, in 2015, 2016 or beyond. Valuations, however, suggest that on a long term basis little growth is priced in and cash returns should compensate adequately while investors wait for growth to materialise. The breadth and depth of European markets also provides an opportunity to benefit from divergent trends, regardless of the prevailing macroeconomic environment.”

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