Catella’s Sven Thorén asks: Where is Europe heading?
Sven Thorén, manager of the Catella Nordic Long short Equity fund, says it is dangerous to extrapolate a good 2013 on the basis of a single good quarter.
Proclamations that the European crisis is over have been heard a number of times over this past winter from people such as Rajoy, Monti, Draghi, Barroso and Lagarde. France’s then-president, Sarkozy, said the same thing in the spring of 2012. Equities and government bonds have since risen sharply. According to a recent survey by the Financial Times, however, around 80 percent of business leaders in Europe do not believe that the crisis is over.
Just before the publication of this article the Italian elections delivered a surprise to the market, with an unexpected outcome. A reminder of the past, and difficult times. The crisis is not over, but the worst nightmare scenario has been subdued as long as investors retain confidence in the central banks. The stock market tends to be the best economic indicator, but we have seen similar rallies in the past three years. The other positive signal is an improved European purchasing managers’ index, but the picture is not unambiguous. For example, France’s purchasing managers’ index is close to its four-year low, and unemployment and budget deficits in southern Europe are still very strained. The banking sector still has significant challenges ahead, and is dependent on the ECB. Holland’s fourth-largest bank, SNS Bank, was nationalised in February, while the world’s oldest bank, Banca Monte dei Paschi di Siena, was given the go-ahead for a government crisis loan. This is despite the ECB’s massive intervention. Corporate earnings forecasts are still being downwardly revised, but the pace has slowed. It appears that the situation will not get much worse, but the economy is still in a delicate situation and an external shock could tip the trend in the wrong direction.
One big difference in 2013 compared to previous years comes from the ECB’s potent loans to banks and the threat of bond purchases through Outright Monetary Transactions (OMT). Interest rates in the crisis-hit countries have declined sharply as a result. The second significant difference is that economic recoveries in the United States and China are providing support for European exporters. The third difference is the large flow to equity markets in early 2013, although this has admittedly slowed a bit in recent weeks.
The fixed income market is sending out different signals. Buyers of high-yield bonds in Europe and the United States are certainly not as optimistic as equity investors. Inflows into bonds have been replaced by outflows. But prices of corporate bonds are not necessarily a warning sign; when prices are close to or above par a bond does not have the same potential as a share. However, it is worrying that CDS prices on a broad index and financial companies are not providing support for the rise in share prices at the start of the year. We also note the positioning of hedge funds (highest net exposure for several years, according to Goldman Sachs). Aggregate short selling of shares is the lowest in several years, and option pricing of equity risk is very low. The difference in pricing between the volatility of shares and high-yield bonds is also the lowest in several years. This indicates that equity investors are relatively carefree relative to bond buyers. Thus, it is likely that we will soon face a correction in the stock market before continuing the rise, given that we avoid external shocks. It is important to emphasise that the structural problems in Europe have not been resolved, so it is unlikely that we will have a normal cyclical recovery.
Catella has a number of products with varying risk profiles to suit all tastes. In my own personal savings I have a mixture of hedge products and pure equity funds that I weight up and down depending on my appetite for risk. The Catella Nordic L/S Equity fund, which I manage together with Jonas Wikström, has had relatively high exposure to equities in early 2013, but has now reduced the exposure somewhat. The fund is up 2.0 percent at 28 February 2013. The difference from the Catella Hedgefond fund is that we have a greater proportion of equities (both long and short) and that we do not own corporate bonds. The risk level of Nordic L/S Equity is higher than for the Catella Hedgefond, but it is still much lower than for pure equity funds. Catella Hedgefond and Catella Nordic L/S Equity are both able to utilise derivatives to a greater degree. With carefully selected exposure we can hopefully navigate through the turmoil after the Italian elections, with lower volatility than the stock market as a whole. Given the promising start of the past two years, followed by a drop in the stock market in spring/summer, it is not possible to rely on extrapolating a good first quarter.