Category Archives: equities

A huge opportunity

The EuroStoxx 50 index is now at the lowest level it’s been since 2012. It’s below the highs seen in 2009. Of course, it’s possible that we’re going to enter another major recession/depression and it continues on down to new lows. Possible, but frankly not very likely, as there is precious little evidence of slowdown, never mind recession in Europe. Sure, the US and Chinese data have been driving things, and there is no doubt that there has been some evidence of slowdown in those economies But even there, growth is positive, and we have seen plenty of uneven growth patches in the US in the quite recent past to make me doubt that the slowdown will last very long. After all, part of the cause of the slowdown is commodity -particularly oil – related, and there are positive effects from lower commodity prices on consumer demand (and on the cost base of many firms) which will take time to come through but will have a growth positive impact down the line. There are clear weaknesses in the world economy in the oil dependent economies – notably Brazil and Russia – but lower oil prices, when supply driven as most agree they primarily have been – are at worst ambiguous in their implications for global growth longer term. Now, as we all know confidence is fragile and a general loss of confidence can lead to a recession even if there is no sensible cause. But consumer confidence is not generally weak by historic standards in Europe or even the US, and as long as that is the case this has to be considered a massive buying opportunity for risky assets, and European equities look the most obvious.

For those who doubt that there is real value, consider the following.

Eurozone GDP at market prices is 8% above the peak level seen in 2008, and 13% above the trough in 2009.

Bond yields are dramatically lower than in 2009. 10 year government bond yields and 10 year EUR swaps are 2.5%-3% lower than in 2009. Most peripheral bond yields are dramatically below their highs. This means that the equity risk premium is at remarkably high levels. You’re being paid about 4% on top of capital appreciation to hold European equities.

Eurozone PMI data is showing almost no sign of slowdown. Sure, the January data was the lowest in 4 months, but 53.6 for the composite PMI is a very respectable number by recent standards, very close to the highs seen since 2011 and broadly indicative of GDP growth in the 0.4% region q/q (according to Markit).

So why are equities so weak? Well, there are some concerns about banks, though it seems  extremely unlikely that exposures to commodity producers are going to bring them down given the improved capitalisation  and reduced risk profiles. But mostly this is panic, flow related moves perhaps with some liquidation at the beginning of the year from some big players. But the economy would have to be a lot weaker than this to justify the weakness of the equity markets. Maybe it will be, but a lot is now in the price.

Of course, you have to be prepared to wear it for a bit if you’re going to make a value based call and buy European equities and other risky assets here. But it is the logical call at these levels.

From an FX perspective the risky currencies are obviously the ones that have the most potential to recover. But it’s not as simple as it used to be, as a lot of the traditionally risky currencies are justifiably lower because of commodity price weakness. And on a relative basis, the USD, which has been one of the most risk positive currencies in the last year, doesn’t have a huge amount going for it on the latest data. The most obvious victim of all this has been the SEK, which ha been sold off heavily because people had it as a risk positive play (though nowadays with negative short term yields it’s not at all clear at this ought to be the case), and I like the SEK here against the EUR and the USD. The EUR may start to worry about ECB action in March especially as we have hit the key retracement levels from the October-December decline in EUR/USD. GBP continues to worry about the referendum and possible Brexit. So FX in general is tricky. But the recovery in the CHF looks like a selling opportunity too.




China -let’s all calm down

The CNY has fallen around 5% since November. That’s a lot for the CNY, but let’s have a bit of context. The CNY has appreciated at a rate of around 5% a year in real terms since 2005 (see below). What happened in 2014 was the strength of the USD accelerated the CNY’s trade-weighted appreciation, so with the USD staying strong in 2015, a decline against the USD is necessary to restore the underlying trend. As the chart shows, we might see some more CNY weakness yet, but it really isn’t a big deal in the greater scheme of things as it hasn’t even broken its underlying uptrend.

As for the Chinese equity market, it’s still above its 2015 (and 2014) lows, which is more than can be said for many European markets.

True, the economy has slowed and may only be growing at 5% or less, and combined with the attempted shift to more consumption and less investment is reducing the growth of demand for commodities, and we have seen the impact of this on commodity prices in the past year, though supply factors have also played a big role. But the weakening of Chinese demand is not noticeably killing growth in the major economies. Growth isn’t stellar, but no-one expected it to be, and recent European PMIs are reasonably encouraging, while US employment growth suggests that the services sector is still more than making up for any manufacturing weakness.

So all in all, the global equity sell off looks like unjustified panic to me. Of course, panic can continue for longer than most can stay solvent, but I am convinced this is a big buying opportunity for European equities, which remain fantastic value relative to the exceptionally low bond yields available.

For FX, the big themes remain the weakness of oil and equities leading to weakness in commodity currencies and JPY and EUR strength (and it is noticeable that the CHF has actually weakened against the EUR). But I wouldn’t get too wedded to the risk off story, especially since the lower oil price will continue to support real consumer demand, and it could of course mean more easing/less tightening globally if they get all worried about low headline inflation, providing further support for growth. I like the SEK as the biggest ultimate beneficiary of all this when the dust clears, despite the Riksbank’s threats.