“Got to Have Faith” – Europe, 2004

| Multi Asset | Macro Views

“Got to Have Faith” – Europe, 2004

The Eurozone has been a source of concern to us for 20 consecutive months in light of alarming signs of broad-based deceleration. A lack of clear governance made Europe, and more particularly the Eurozone, the weakest link in the investment world, in our view. But things seem to be changing. We see (very) early signs of macro stabilisation and consumption growth looks firm. We also see too much pessimism in markets as these first signs of improvement surface. With the ECB’s new President pushing for more fiscal spending, an extremely low euro and a lower exposure to the trade war, we think European growth assets could become more appealing. We need to strengthen our faith here a little more, but we have already started reducing our defensive positioning.

What’s Next?

Heading Towards 2011?

We have been worried about the European situation for almost two years now. Our European Growth Nowcaster reached a peak in January 2018, just like it did for the rest of the developed world. However, unlike the rest of the world, it has collapsed since then. The indicator was at 0.67 in January 2018, where zero represents growth in line with potential. From this extreme level, the fall has been sharp: by March this year, the indicator had plunged to -0.19, very close to our -0.3 recession threshold and indicative of growth being below potential. Historically, when an economy reaches that threshold, its GDP has typically started to contract: Canada and South Africa are recent examples. The Eurozone managed to remain above this threshold but this -0.19 level is concerning. Our Growth Nowcaster has only been lower 30% of the time: a clear sign of growth being at risk.

Moreover, the fall was not just sharp, it was also broad-based, unlike other developed economies. Since February 2018, on average, across the 41 data series used to create our Eurozone Growth Nowcaster incorporating seven economic dimensions (such as consumption, production expectations, housing or investment), 65% of them were declining. In March 2018, this number increased to 81%, with its 30-year historical maximum at 90%. Little wonder we started feeling nervous about the European economy, with 2011 still fresh in our minds.

Macro: A New Hope

There are early signs that things are finally stabilising, an unexpected but welcome breather after almost two years of economic slowdown. Four key elements are potentially turning this very bearish story into something more positive:

  • First, our growth nowcaster has stabilised over the past two months, even retracing some of the ground lost in September, climbing back to -0.10. In isolation, that would not be enough to be good news, but the percentage of deteriorating data also significantly decreased within a month, currently standing at 50%, a level not reached since December 2017. This improvement reflects better production expectations, employment and housing numbers. Again, we are not saying the Eurozone is out of the woods, but early signs are appearing. Also, consumption in Europe has remained firm so far and, beyond export-dependent Germany, other countries are likely to profit in this low rates period through housing, e.g. Spain, Italy and France.
  • Second, the euro has dramatically declined over these 20 months, from 1.25 vs. the US dollar in January 2018 to 1.08. This 13% decline is also likely to have had a positive influence on European exports, especially for Germany. The renminbi also lost 13% over the same period, creating greater investor confidence in China given the positive impact of these currency variations on its economy. Could the same happen to Europe?
  • Third, unlike 2011, the ECB continues to show a readiness to act. This should have a positive impact on the European housing market overall and keep the euro bulls at bay as the new round of QE starts to increase money supply.
  • Finally, new ECB president Mrs. Lagarde will likely favour further fiscal stimulation. The countries with the largest fiscal surplus (mainly Germany) could be tempted to increase their debt at a negative cost to fund infrastructure projects.


Sentiment/Valuation: Bearish Sentiment Overly Priced

The final element we are seeing is excess pessimism across markets, which has caused hedging assets to become extremely expensive. This is even more the case for European assets.

Sentiment is negative now that markets have recovered from their Q4 2018 collapse, driving people to take profits and to hedge themselves. The equity skew is currently as high as in January 2018: a clear sign that investors are seeking protection. Also, portfolio positioning in European equities has steadily decreased, as shown when studying the beta of multi asset portfolios to US and European stocks. If investors only recently decreased their holdings in US stocks (basically since July 2019), they gave up on European equities in January 2018 and have steadily reduced their investments there since then (as measured from the beta of a pool of multi asset funds to the S&P 500 and to the Eurostoxx index).

We see this situation as more of an issue among regional equities where valuations look uneven. According to our estimates covering a large spectrum of valuation metrics such as price-to-book, earnings yield or sales-to-book ratios, there is now a large difference between the very expensive US stocks (above their 80th historical percentile) and the very cheap Japanese and emerging stocks (30th percentile).

Interestingly, European stocks are sitting in a higher range without being as expensive as US stocks (70th percentile). Historically (1990-2018), when they reached these values in terms of expensiveness, European stocks delivered a positive performance in the following three to six months. In addition, most of the metrics we use are based on forward-looking earnings/sales, which are currently very pessimistic for European stocks. Should these numbers improve in the upcoming earning season, these valuations could actually be even lower than where they stand today.

In our opinion, the case for European assets is still early, and we have only lightened our bearishness on them for now, gaining an exposure to global equities rather than regional ones. However, European equities contain a larger portion of value stocks and a macro bottoming in Europe could ignite a value rally that could help European stocks to outperform. If the macro situation does improve, this could become an interesting investment theme to add to our constructive positioning in growth assets.




Got to Have Faith

Europe





Strategy Behaviour

Our medium-term view is currently more constructive, as we are still overweight growth assets and underweight real assets. Given the current cost of hedging, we are using forex-based strategies exposures to hedge ourselves against adverse market conditions.

Performance Review

Over the month of October to date, the Uni-Global – Cross Asset Navigator fund lost -0.63% versus 0.14% for the MSCI AC World index and -0.46% for the Barclays Global Aggregate (USD hedged). Year-to-date, the Uni-Global – Cross Asset Navigator has returned 9.51% versus 16.36% for the MSCI AC World index, while the Barclays Global Aggregate (USD hedged) index is up 8.26%.

Unigestion Nowcasting

World Growth Nowcaster

World Growth Nowcaster

World Inflation Nowcaster

World Inflation Nowcaster

Market Stress Nowcaster

Market Stress Nowcaster

Weekly Change

  • Our world Growth Nowcaster increased last week, particularly in developed countries.
  • Our world Inflation Nowcaster fell again last week, particularly in the US and the Eurozone.
  • Market stress decreased after a more volatile period.

Sources: Unigestion. Bloomberg, as of 14 October 2019.

Navigator Fund Performance

Performance, net of fees2018201720162015
Navigator (inception 15 December 2014)-3.6%10.6%4.4%-2.2%

Past performance is no guide to the future, the value of investments can fall as well as rise, there is no guarantee that your initial investment will be returned.

 


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Unigestion UK, which is authorised and regulated by the UK Financial Conduct Authority, has issued this document. Unigestion SA authorised and regulated by the Swiss FINMA. Unigestion Asset Management (France) S.A. authorised and regulated by the French Autorité des Marchés Financiers. Unigestion Asia Pte Limited authorised and regulated by the Monetary Authority of Singapore. Performance source: Unigestion, Bloomberg, Morningstar. Performance is shown on an annualised basis unless otherwise stated and is based on Uni Global – Cross Asset Navigator RA-USD net of fees with data from 15 December 2014 to 14 October 2019.

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