In this week’s bulletin:
- Wall Street equities are making record gains with the S&P 500 index last week breaking the 1,800 level.
- Money has continued to flow back into global equities, with US and European stocks attracting large inflows.
- US fund managers are increasing positions in European banks, with a view to the region’s economy catching up.
- European stocks still offer better value than the US, while sentiment has eased towards eurozone bonds
A tale of two Europes
The question of Europe divides investors as sharply as it does politicians and voters. Good-value stocks and world-class businesses have compelled many to invest in Europe, while signs of economic recovery and strong central bank leadership are held as further reasons to have faith in Europe as an investment destination. For others this Panglossian view overstates the case for the region’s businesses, its economic recovery and its finances. Whether or not Europe is entering the best of times or the worst of times, the fact remains that the eurozone crisis is yet to run its course as an influence on investment decisions in the region.
Monday 25 November 2013
The European conundrum for investors is perhaps no more puzzling than the problem faced by anyone peering into other parts of the global economy and its markets: the test for all, from fund manager to lay investor, is to retain a clear perspective in a world deluged in easy money and low interest rates in the years since the financial crash. The questioning of valuation and opportunities is a given for those looking to pursue long-term investments at any point of any economic or market cycle. But one certainty that the divergence of opinion over Europe does underscore is that the recovery of the global economy still has some way to go.
As the advanced economies take further steps on the path to recovery in varying states of strength – with the UK and US ahead of Japan, and the eurozone trailing at a limp – the global equity markets continue a steady march driven by loose monetary policy. The crucial role of the US Federal Reserve’s $85 billion-a-month asset-purchase scheme in this equity market rally was underscored last Wednesday when the S&P 500 index took a dip on renewed expectations of an early tapering of its quantitative easing (QE) programme.
Although the Federal Open Market Committee’s minutes of its October meeting revealed that it does not see a tapering move occurring “in coming months”, markets are again anticipating a possible early end to QE even before Janet Yellen takes over as chair of the Fed in January. But after the initial fall, US stocks quickly regained their upward momentum as the Fed’s emphasis that “tapering did not equal tightening” looks to have had some effect on markets. Deutsche Bank strategist Alan Ruskin said the tone of the minutes was a strong indication that officials “are keen to taper, and will certainly taper if data is OK”.
Moreover, it emerged that the committee is considering further ways to stimulate the US economy. One approach is to axe the 0.25% interest rate paid on the $2.5 trillion reserves that depository banks hold with the Fed and which have accumulated with the help of QE. The Fed believes that cutting the interest rate could bring down shorter-term interest rates and further boost the economy. The committee is also looking at lowering the 6.5% unemployment threshold at which level the Fed would consider a rise in the interest rate that has been held at 0.25% since January 2009.
After the Fed revealed its options to squeeze more life into the US economy, the S&P 500 reclaimed the losses made earlier in the week with the market more comfortable about an early move by the US Federal Reserve to start reducing QE. The S&P 500 rose 0.5% on Friday and closed the day and the week at a record level of 1,804 points – a 0.4% gain over the five-day period that edged the Wall Street index for the first time above the 1,800 level. US communication sector shares took strong gains on the news that Comcast was weighing up a bid for Time Warner Cable, with the two companies gaining 4% and 10% respectively on Friday.
In Europe, the FTSEurofirst 300 index rose by 0.1% on Friday to rest at 1,297 points, although it was down marginally over the week from the five-year highs reached earlier in the month, as the European Central Bank (ECB) president Mario Draghi played down any suggestion of a negative deposit rate. However, in London, the FTSE 100 index succumbed to its third straight weekly decline to 6,674; with the biggest faller on Friday being TUI Travel which lost 8% after Norwegian shipping tycoon John Fredriksen sold his 5% stake in the UK leisure group and switched into its European owner TUI AG. Meanwhile, the Nikkei 225 Average index in Tokyo rose 1.4% over the week to close at 15,382 points amid upbeat economic assessments from the Bank of Japan.
The US government bond market also looked steadier about Fed policy with the 10-year Treasury yield moving 9 basis points (bp) to a two-month high, before settling at 2.75%. German sovereign bond prices dipped despite speculation that the ECB would adopt a more accommodative policy stance to counter the eurozone’s slowing pace of inflation and faint economic growth. German bond yields were up 4bp over the week to 1.74%. In the UK, the 10-year gilt yield was up 4bp to 2.79% over the week as optimism over the UK economy triggered speculation that interest rates could rise sooner than expected.
US stocks are enjoying their best year since 1997 as investors remain unperturbed by unspectacular economic growth and a high level of unemployment. With another record performance last week, the S&P 500 is up 30% over the last year. Although talk of an equity bubble has re-emerged, Yellen, in her recent appearance before the Senate banking committee, suggested that the equity market was not overpriced and the one-year forward price/earnings ratio is close and not above its historical high. In contrast, other measures suggest that US stocks are well above their historic long-term norm.
Whatever the relative merit of different approaches to valuations, there are concerns that the influence central banks and markets are exerting on each other is inflating assets. And the rapid rise of US equity prices this year without strong economic growth is seen as a reflection of the role the Fed now plays in the market, raising fears of a correction if the economy and incomes do not accelerate soon. But momentum in markets is a good thing while it lasts, and investors are benefiting from QE. And, while US central bank policy stays in place, including its expressly stated strategy to very gradually ease off QE, equity markets can continue to move upwards – even if the pace of that momentum slackens.
Money has continued to flow back into global equities, with US and European stocks attracting large inflows, according to latest data from Bank of America Merrill Lynch (BofA) and EPFR Global. Inflows to equity funds have reached a record level of $235 billion so far this year. Brian Leung, global equities analyst at BofA, said: “We are seeing more investors putting their dollars into equities than bonds, and significant differentiation between equity inflows and bond inflows which are the slowest since 2008.” US winners in this environment include FedEx, Google, Amazon and Microsoft with rallies of 40% or more this year. However, some are concerned that corporate America’s revenues are not matching this valuation growth.
However, there’s little sign of what legendary investor Sir John Templeton labelled a phase of “euphoria” in the US or other advanced markets in spite of the rally. BlackRock head of strategic asset allocation Richard Urwin recently picked up on this theme and argued that markets are somewhere between “hope and relief”. For all the talk of an overextended market and metaphors of punchbowls, equity markets seem to be savouring with moderation a well-earned vintage year.
Stateside easy money is making its way into Europe with US fund managers taking increasing positions in eurozone businesses, particularly its banks, with a view to the region’s lagging economy gradually catching up with the UK and US. The value of the shares owned by US-based funds in the eurozone’s ten largest listed banks has risen 40% from June to €33 billion, Thomson Reuters data shows. The view from the US is that European banks are looking cheap as signs increase that the worst of times are over for the eurozone. The European Central Bank is also about to carry out its asset quality review of eurozone banks and stress tests to establish the financial health of the region’s lenders.
European stocks are still offering better value than their US counterparts, which has also attracted UK fund managers to the region and its banking sector. Eurozone shares trade at 1.7x their book value, while US equities are at the 2.5x level. There is a view that there is a lot of optimism behind this perspective on Europe with a risk remaining that the eurozone’s recovery will not take root in 2014.
Although second-quarter growth figures for the eurozone were encouraging, business confidence surveys fell back again in November after a steady rise to September. And, while Germany continues to drive the region’s growth, purchasing managers’ indices for the region’s periphery and France look weak.
Meanwhile, there has also been a renewed enthusiasm for eurozone government bonds, indicating that some of the negative investment sentiment has begun to ease. Eurozone government bonds have returned almost 5% over the past 12 months, outperforming US Treasuries. If Europe’s governments can steer through austerity, its economies gather pace and corporate earnings start to rally, then the faith of certain investors that there is a fundamental quality available in Europe at attractive values will be vindicated.
Jacob de Tusch-Lec of fund manager Artemis has been venturing since 2011 into some of the periphery nations hard hit by the eurozone crisis. “We’ve had two years where you could throw a dart and the further south that dart landed, the more money you made,” commented Tusch-Lec. The MSCI Europe over the past 12 months has gained 24%, compared with the FTSE All-Share’s 22% rise; while the MSCI Greece index is up 61%.
Fund manager S. W. Mitchell Capital shares this upbeat view for European businesses and the region’s economies, and has focused on companies in the eurozone that are generating domestic earnings. “We believe that the opportunity to invest in more domestically orientated companies is particularly striking,” explained founder Stuart Mitchell. While many of the best-quality international growth stocks are now “just too expensive”, Mitchell notes that some domestic European companies are trading at discounts to their US equivalents of around 50%.
Mitchell has consistently argued that factors such as the modest growth of the eurozone’s overall debt and Germany’s trade surplus underpin the region’s strength relative to the US and UK. “Our firm belief has been – and remains – that the eurozone economies are both fiscally strong, and more business competitive, than their Anglo-Saxon counterparts.” That raises a far-reaching question not so much about Europe but about the economic and financial model of the two English-speaking nations on the other side of the Channel and the Atlantic…