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Elections in Asia – Pinning Hopes on the “Chosen One”

On a recent trip to Jakarta, I detected a palpable sense of excitement and support for the city’s current governor, Joko Widodo, who is vying for president in the upcoming election—and who has already proven to be a capable leader in many respects. A few days later, in India, I felt a similar vibe among Indian voters who were gearing up for their own impending national elections. Many in the business community seem to have their hopes pinned on Narendra Modi, the current Chief Minister of Gujarat, to become India’s next Prime Minister. What surprised me in both countries was the general public view that economic prospects hinge entirely on their respective victories.

I see these high expectations, particularly among the business community, as a sign of hunger for good leadership and better governance. The crux of the issue, as I see it, is that both candidates symbolize an end to the lackluster policymaking and slow implementation of important reforms of the past few years—such as land acquisition in the case of India. But, unfortunately, much less attention is being paid to the underlying fundamentals in these economies.

While the renewed hopes for fresh change in each election are understandable, excessive anticipation risks overstating the importance of such an event. It can also understate the process through which economic policies and reforms are initiated and implemented.

In Indonesia, the current administration has made some tough decisions on fuel subsidies, and the Bank of Indonesia seems resolute in striking the right balance between growth and inflation. In recent conversations with ministry officials, we detected a quiet sense of confidence despite the recent challenges that have faced the Indonesian economy. They reminded us that many senior officials and technocrats have lived through much worse during the Asian Financial Crisis of 1997—98, and are now battle-ready should issues arise.

In India’s case, its outgoing government has been trying to clear a logjam in approvals of investment projects. The newly created Cabinet Committee on Investment has been active in facilitating approvals for a variety of projects in the energy and infrastructure sectors. Furthermore, the political dialogue in the run-up to the current elections has been focused on issues like governance and economic development instead of social identity and welfare systems. The incoming government will find it hard to ignore the pressing need for stimulating growth through a more coherent and consistent set of economic policies.

So, this is all to say that, as voters queue up at the polls, I would caution against expectations of a quick fix or a fixation over the short term. As in much of the rest of Asia, India and Indonesia are attempting to tackle their issues and this makes us optimistic for the future. We look forward to an environment of better governance that is critical for both social and economic progress.

Opinion column by Sharat Shroff, CFA. Portfolio Manager at Matthews Asia

The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.

“We Have Decided to Halve our Overweight to Equities and Move to a Neutral Position in Cash”

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“Hemos decidido reducir a la mitad nuestra sobreponderación a bolsa y pasar a neutral nuestra posición de efectivo” — Photo: Alvesgaspar. “We Have Decided to Halve our Overweight to Equities and Move to a Neutral Position in Cash”

Global equity markets experienced volatile trading but moved higher overall during March. Key influences included the crisis in the Ukraine and Russia’s annexation of Crimea, concern over China’s economic and financial prospects, and the outlook for monetary policy in the US. Tensions between Russia and the West over the Ukraine rose ahead of a referendum in which Crimea voted to re-join Russia, but subsequently eased. Disappointing economic figures from China included an unexpectedly large fall in exports of 18% in February, dashing hopes that foreign trade will drive the slowing economy. The first Chinese domestic bond default, which took place in early March, also hurt investor sentiment. However, sentiment toward China recovered late in the month when Premier Li Keqiang said that Beijing was ready to boost the economy.

In fixed income markets, the yield on the 10-year treasury ended March at 2.72% compared to the 2.67% level seen at the end of February. However, yields experienced considerable volatility over the period, reflecting the crisis in the Ukraine, concerns over China’s economic outlook and jitters over US monetary policy. The latter followed remarks by Janet Yellen, the new head of the Federal Reserve, indicating that US interest rates would rise sooner than expected. However, markets subsequently regained their composure. On the other side of the Atlantic, Portugal’s 10-year yields slipped below the 4% mark for the first time in four years towards the end of March. Spanish and Italian bond yields also touched multi-year lows after investors interpreted remarks by a European Central Bank official as indicating that the bank would consider adopting quantitative easing to relieve the eurozone’s problems. Spanish 10-year bonds fell to 3.23% on the final day of trading in March, while the yield on comparable Italian bonds declined to 3.29%.

Meanwhile sentiment towards emerging markets in general has improved. The J.P. Morgan EMBI+ Index (on a total-return basis) delivered a positive return of 1.37% over the month and 3.45% over the quarter, while emerging market equities have also rebounded. The MSCI Emerging Markets Index (total return, local currency) gained nearly 2% in March, although it remains slightly down over the quarter. However, we are concerned about the outlook for China. In the past few years the country has seen an explosion in credit, facilitated by the shadow banking system as retail investors have been enticed into an array of savings products, where the underlying investments are often opaque, promising heady returns. It is clear that the authorities are now concerned about this situation and investors are surely going to see an increasing number of these funds being declared bankrupt. The growth in credit in China has been very rapid and it is difficult to find examples of such occurrences ending well. At best we are likely to see a material reduction in China’s growth rate, but the outcome could be far worse. Clearly the prolonged underperformance in Chinese equities has discounted some of these concerns, and valuations are low relative to other markets. However, the unwinding of the Chinese credit bubble could severely test China’s financial system, and unnerve investors more generally.

Consequently we have decided to halve our overweight to equities and move to a neutral position in cash. We will remain overweight in equities as valuations are largely reasonable, although less compelling than was once the case. We have also decided to increase our underweight to Asian equities on the concerns over China, and increase our overweight to Japan in the belief that the impact of the consumption tax will be less damaging than is feared. Although we remain overweight in equities, it would be fair to say we are less optimistic than we have been. Within fixed income, core yields are going to grind higher, and there is much less value in credit given how far spreads have tightened. Only emerging markets appear to offer any real value, but given the risks in terms of China, geopolitics and the macroeconomy, we are wary of increasing our weighting at present. The good news is that this environment is likely to continue to provide opportunities for stock pickers, which we should be able to exploit.

Monthly investment comment by Mark Burgess, CIO at Threadneedle

Brave New World

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Un mundo feliz — Photo: Ed Schipul from Houston, TX, US (running with the seagulls) . Brave New World

The major themes driving markets in Q1 were all negative: disappointing economic and corporate data, recurrent problems in emerging markets, and the political crisis in Crimea. Still, the resilience of markets (global equities +1.4%; emerging markets -0.4%[1]) against such a challenging backdrop suggests underlying market strength and the promise of better returns in the months ahead if the news flow does improve.

While we have some sympathy for this theme, we’d be wary of getting carried away with it. One reason is that market resilience in recent months seems partly due to the fact that our positive outlook for growth in the major economies has now become a consensus view. Investors have probably disregarded weak data because they expect a rebound in the next few months. If that’s right, then risk assets might need good data just to validate current expectations. Also, it’s possible that any positive growth news in the UK and the US will shift investors to a more bearish view on monetary policy.

Monetary policy really matters – it has been the key driver of financial markets in the post-crisis era. Q2 2013 was a high point for investor confidence in central bank liquidity provision. Since then, markets have begun to accept that US quantitative easing is ending and have begun to focus on the timing of the first interest rate hike. The imprint of this theme on markets is clear. While global equities and high-yield bonds have recently made new highs, every other asset class is still trading below its 2013 peak.

The broader theme here is that markets are in the midst of a transition away from a world in which central bank liquidity boosted all assets, to a world of more limited policy support. In the major economies, the expansion of central bank balance sheets has peaked. In China, policymakers are now focused on restraining the credit boom. In other emerging markets there has been more policy tightening than easing. As markets confront the limits to policy support, the growth outlook becomes increasingly important. In gloomy emerging markets, positive growth surprises would be unambiguously welcomed. In the UK and the US, market reaction to positive growth surprises will be somewhat tempered by concerns about the impact on monetary policy.

Liquidity-driven markets are powerful and straightforward: everything goes up. We are now in transition to a more complex environment in which market reaction to news will be more nuanced and less predictable. That’s a world in which we’d expect asset performance to remain quite widely dispersed. A world with more volatility, more challenges and more opportunities.

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By Paul O’Connor, Co-Head of Multi-Asset at Henderson Global Investors

[1]Respectively: MSCI World Index, MSCI Emerging Markets Index, total returns in USD

Dear President Draghi…

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Paris, 17 April 2014

Dear President Draghi,

On two previous occasions, I felt the need to congratulate you for an exemplary first year in office. Today, it can safely be said that in just two and a half years at the helm, you have made the ECB the key institution in the European construction process. You have prevented the euro area from imploding and allowed its most vulnerable members to re-enter the bond market.

The record is plain to see. In January 2012, yields on Italian and Spanish 10-year government debt were close to 7% and 5%, respectively. They have now been halved. Even better, because you made your support for these states contingent on their adoption of a code of good conduct – the Fiscal Compact – it took only minimal ECB involvement to get results. Renewed investor confidence was enough to get the markets working the way they are supposed to.

So these are impressive achievements. But will they really fit the bill? Unfortunately, the answer is no. The two countries I mentioned are expected to produce growth of less than 1% and have an inflation rate barely above zero. This means they will be shouldering an even heavier debt burden this year, with debt service still outstripping nominal growth by a sizeable margin. True, the ECB can only go so far in stimulating member state economies. Yet its duty is to gauge the recessive impact of any fiscal consolidation and structural reform programmes. It is therefore imperative that the European Central Bank counterbalance the inevitable hardships with a resolutely accommodative monetary policy geared to weakening the euro. This would help European companies move back up the competitive ladder and push inflation up into the vicinity of 2%.

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What decisive steps will be required to make that happen? I would suggest (1) a zero interest-rate policy, engineered through a token 0.25% cut in your benchmark interest rate; (2) a sovereign bond buyback programme of €50 billion a month, with the breakdown based on the relative economic weight of the various member states. These purchases would amount to 6% of eurozone GDP a year, and it goes without saying that they should not be sterilised.

The higher confidence in the European construction process you have brought about has to be consolidated. At this stage, Machiavelli needs to morph into Super Mario – an equally stellar role when the task at hand is to keep deflation from clogging up Europe’s intricate economic plumbing.

That, in any case, is my hope, and I have no doubt that you can and will do whatever it takes.

Respectfully yours,

Edouard Carmignac

You may also access Mr. Carmignac’s letter through this link.

Why China’s A-Shares Matter Now

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Las acciones clase–A del mercado chino cobran relevancia: ¿Por qué? — Wikimedia CommonsPhoto: Heurik at de.wikipedia. Why China's A-Shares Matter Now

Although we often receive questions on mainland China’s A-share equities, which trade on the Shanghai and Shenzhen Stock Exchanges, we currently invest in Chinese equities primarily via Hong Kong-listed companies and also by way of U.S.-listed Chinese firms. China’s domestic A-share market remains largely closed to foreign institutional investors. The only way for foreigners to participate in this market is to enroll in China’s Qualified Foreign Institutional Investor (QFII) program or invest via a manager who has a quota in this program. Even still, relatively few QFII licenses have been granted.

China’s A-share market performance has been lackluster over the long term. Ten years ago, the Shanghai Composite Index traded at approximately 1,800 and had a stellar run to 6,000 in late 2007. But the index has since erased most of its gains and is now trading back around 2,000. This may leave you to wonder: do the A-share markets reward long term investors?

There are a couple of unique characteristics of China’s A-share markets that have, either directly or indirectly, contributed to the country’s stock market performance. First, a key issue has been China’s “non-tradable shares,” which were awarded to the management teams and employees of listed state-owned companies. As their name implies, these shares have been disallowed from trading in the open market. But after a long reform process of the non-tradable shares in from 2005 to 2007, individuals could gradually sell their shares. Over the next few years, batches of non-tradable shares continued to become available for trading and created a situation of excess liquidity, weighing down stock market performance.

Unlike in most markets, another characteristic unique to the A-share market is its trading volatility. This results from the dominance of the A-share market by retail investors, who make up 80% of the market and tend to be short-term market-timers.

All of that said, many of these comments are backward-looking. The non-tradable shares issue peaked around 2009 and provokes less discussion today. High volatility continues to be challenging, but steps have been taken to introduce more institutional and QFII participants to the market, encouraging a longer term investment mentality.

As these markets evolve, they may present more attractive opportunities for investors. For starters, valuations are currently enticing, trading at price-to-earnings (P/E) multiples* currently estimated by Bloomberg at 8x for 2014 and 7x for 2015. These valuations are approaching 10-year historical lows. The A-share markets also broaden the pool of stocks from which investors may choose. For example, in certain fast-growing Chinese sectors as health care, consumer and technology, there are many more selections on the A-share market, compared to the relatively few numbers of firms listed in Hong Kong or the U.S. We may also be able to research the A-share competitors of businesses we currently study.

Matthews Asia currently holds no exposure to A-share equity markets, and we are not commenting on the domestic markets as a whole. Careful stock picking is particularly important here since this market does have its fair share of poorer quality companies, including a large representation of state-owned businesses. However, such a large opportunity set does have the potential for investors to choose from a larger menu of quality companies.

*A valuation ratio of a company’s current share price compared to its per-share earnings.

Opinion column by Winnie Chwang, Senior Research Analyst, Matthews Asia

What We Expected May Be What We Get

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Podríamos tener lo que esperábamos, a pesar de todo — Photo: Torsten Bolten, AFpix.de . What We Expected May Be What We Get

With the first quarter of 2014 behind us, let’s consider where we stand now versus our outlook at the beginning of the year, when we were favoring the US equity market over other equity markets. And our outlook for fixed income was based on a bias toward higher interest rates — not a dramatic hike in rates, but a downward drift in bond prices across the board. So we were favoring credit and shorter maturities.

Among US stocks, we liked the technology sector, where we noted some exuberant pricing but found that the broad swath of tech companies were not trading at bubbly prices — and after the recent market selloff that remains a truism.

My thoughts early this year were that low energy prices and labor costs would persist, keeping the US manufacturing sector competitive. On the corporate side, we would see more spending on capital, or capex, to replace some of the longest-lived assets in history. And on the household side, more jobs in manufacturing would drive pent-up demand for housing and automobiles, helping to revive the construction sector and fuel the economy in general.

Then what happened?

January came along, and we got some poor results from the consumer, with the first inklings that bad weather was at least partly to blame. Then in February there were heavier snowstorms and weaker numbers out of the consumer and factory sectors. While the market grew concerned when job gains seemed to decelerate and hours worked fell, many — but not most — technology stocks reached very heady valuations.

I want to stress that the private sector is still growing at 3.3% to 3.4%, and that’s what really matters to investors

How do things look now in April, as we enter the second quarter of 2014? The numbers from March are starting to come in. US labor markets continue to heal, with nonfarm payrolls again exhibiting modest expansion including upward revisions to January and February. More important, we saw an uptick in the workweek — a figure that I emphasize. So even though the pay rate received by workers has remained flat, which has favored corporate profits, the growth in jobs and the longer workweek bias the total wage bill toward better consumption going forward.

My conclusion? Even after last year’s nearly 30% gain in the S&P 500 Index and this year’s turmoil in the technology sector and the broader markets, the story of the durable US expansion remains intact.

The bigger picture

How do we measure the US economy against what’s occurring in the rest of the world? Let’s go through US trading partners. Number one by percentage of US GDP is the Eurozone, which on the whole is showing better and faster growth. This may not be a V-shaped recovery, but jobs, factory orders and fiscal responsibility all look to be improving in Europe. Another big trading partner is Mexico, and the numbers there remain solid.

Moving across the Pacific to Japan, we saw growth ticking up after the yen was devalued, although some indicators seem to be slowing down right now as the value-added tax is kicking in. I would say the outlook there is a little more uncertain.

China stands out among emerging markets for its major role in the global economy, but it accounts for only 7% of total US exports — and that share is declining. With exports contributing about 12% of the US economy, China directly influences only about 1% of US GDP. I don’t see any near-term excitement coming out of the numbers from China.

What matters on the investment side

We expect the equity market to focus on fundamentals, and earnings season for the first quarter has just begun. S&P profits expanded in the last quarter of 2013, and so did margins. Based on a broader number including privately held as well as publicly traded companies, the profit share of GDP — or the percent of the economy going to capital — actually rose again last year, despite the many predictions that it would have to revert back to the mean. This is really important because we haven’t seen a recession since World War II when the profit share of GDP was rising.

Looking at interest rates, which matter to all financial markets, we’re getting to see the new Federal Reserve chair in action. Janet Yellen seems to be accommodative, though with a view that the US central bank eventually has to step aside and let the market determine longer-term rates. So we continue to expect a slow drift higher in long- and medium-term rates, while short-term rates are likely to remain contained, since she apparently has no intention of raising the target federal funds rate as long as US inflation persists on the low side.

So to sum up, despite all the gloom sellers on the news during the long, dark winter, it appears that a lot of the slowing in the first quarter was temporary. And even though now, in the bright light of spring, we’re seeing a dramatic selloff, we think that US real GDP will continue to expand at around 2¼% — the same moderate pace we’ve been witnessing throughout this whole cycle. Finally, I want to stress that the private sector is still growing at 3.3% to 3.4%, and that’s what really matters to investors.

Post originally published in James Swanson’s blog “On the Lookout“. James Swanson is Chief Investment Strategist at MFS Investment Management

Global Demand for Property– Europe Well Placed

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Real estate as an asset class remains well placed in the current environment, with investors continuing to rotate from bonds into other yielding assets with growth potential.

A recent report by DTZ supports this, showing that there is currently $354bn of capital targeting the real estate sector globally. Europe is accounting for an ever increasing share of this: here, investors have moved up the risk curve with secondary assets and markets such as Spain and Ireland back in vogue. Within the listed property space we have seen a number of newly listed opportunity funds raising money on the equity market to exploit the potential in these markets, focusing on the distressed assets still emerging from overexposed banks.

However, our core focus remains Northern Europe. The UK property market has been a standout performer and has started this year as it finished the last. An impending City and West End office supply shortage, combined with an uptick in occupier demand looks set to force rents materially higher. With financial strength and development exposure, the UK real estate investment trusts (REITs) remain well positioned to take advantage.

In mainland Europe, we remain cautious on the outlook for retail landlords. Inflation is low, online sales are growing, and a nascent economic recovery offers little prospect for rental growth. However, we feel the French office market may soon offer some value with rents now bottoming out. Listed companies, such as Icade, may provide an opportunity to exploit this theme, with shares now trading at discounts to asset values. In Sweden, property fundamentals remain robust with relatively healthy gross domestic product (GDP) growth likely to feed through to capital values in the stronger cities. In Germany, we continue to see value in the residential stocks where demand for rented accommodation is driving modest, but reliable rental growth.

Following a strong run in recent years, we must ask how much of the good news is already reflected in share prices. Our view is that property shares while no longer cheap continue to offer value given the potential for rental growth as economies recover. However, increasingly successful stock picking will be required in order to exploit pockets of stronger growth and greater value.

Guy Barnard, Fund manager of the Henderson Horizon Global Property Equities Fund and Pan European Property Equities Fund

Asia’s E-Commerce Trends

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Tendencias del “E-Commerce” en Asia — Wikimedia CommonsPhoto: PD Photo.org. Asia's E-Commerce Trends

On a recent research trip, I went to Beijing, Hong Kong, Tokyo and Melbourne and spoke with Internet companies in industries as diverse as automotives, travel and real estate. I also met with several e-commerce companies with varying Internet penetration rates. As growth rates for new Internet users across parts of Asia level off, comparing these firms offered me an interesting glimpse into the potential opportunities and challenges facing the region’s newer Internet firms.

Most of Asia’s Internet companies still rely primarily on advertising revenue to make money. Frequently, such firms can also tap into subscription services whose pricing structure is usually a simple fixed payment regimen. Given the relatively low penetration rate of online channels in most everyday businesses, this is not a surprise. In this growing market, companies compete for online customers by expanding their sales forces to promote their brands. The productivity gain that their customers get from conducting their businesses online creates sufficient return on investment (ROI) to justify investment in IT capital like software and hardware. This trend has benefited Internet businesses in their early development.

But nowadays, we are seeing younger Internet companies modeling their businesses on performance-based methods, producing revenue only when a sale or a lead is generated. We are also seeing the use of new technologies that set them apart from conventional Internet players and could potentially become a disruptive force in the market as the technologies lower the cost of using Internet services and cater to smaller merchants, which may not be the core market segment for existing Internet firms.

In more developed markets, such as Japan and Australia, the focus of monetization has shifted from growing the volume of Internet users to increasing average pricing per user. This shift brings challenges to many incumbents’ business models. To achieve growth, firms in these markets need to raise prices. They need to know which customers are willing to pay for their products and services. Another challenge arises as increasingly sophisticated stakeholders, including advertising agencies and business owners, demand that Internet vendors demonstrate that page views or users’ time spent on the website actually translate to higher ROI. In real estate or automotive listing websites, for example, a higher conversion rate from online traffic to lead generation reduces costs incurred by real estate agents or auto dealers to sell a property or a car. Internet companies can add more value with differentiating services like market intelligence that help attract new users and increase the “stickiness” of existing users.

With more than 1 billion Internet users, Asia is already the world’s largest Internet market. But Internet penetration rates for Asia’s most developing countries are still over a decade behind the region’s more advanced economies. It will probably take many years for Internet markets in developing Asia to mature. Regional leaders need to continue investing in R&D capabilities because they will likely face challenges to their existing business models as markets evolve. In addition, the business environment they face will be different because of disruptive technologies like smartphones and 4G that were limited or non-existent a decade ago. Now is not the time for them to be complacent. Only the Internet companies that can adapt to new technologies and continue to demonstrate value should be able to survive this intensely competitive landscape over the long run.

Are Stocks Getting Stretched?

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¿Está sobrevalorada la bolsa? — Photo: Jacob Garcia. Are Stocks Getting Stretched?

Last month we observed the fifth anniversary of the US equity bull market, which started after the S&P 500 Index troughed at 676 on 9 March 2009. With events in Ukraine and other geopolitical hotspots to distract us, we may not have celebrated with cake and candles, but we’ve reached an important milestone.

Are we on track for another year of stock gains, or have we reached the market top? Let’s take a look at some equity valuation measures to see where we stand.

Stock market fairly valued?

Valuations continue to be front-page news. Certainly commentators are saying that valuations are stretched, especially in a fragile macro world. But if we compare valuation metrics today with the two previous market peaks, we can see that the private sector is in much better shape this time around:

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I would like to point out that earnings per share (EPS) are notably higher, while the trailing price-to-earnings or P/E ratio of the market is not yet at the levels we saw at the tech bubble’s peak in March 2000 or even in the not-so-bubbly October 2007. Other trailing measures also suggest that valuations are not overextended.

What about indicators that look ahead, rather than behind us? If we consider the forward P/E based on analysts’ estimates of earnings over the next 12 months, we find the market in roughly fair value territory:

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To account for the ups and downs in the business cycle, we can adjust earnings by looking at the Shiller P/E, which uses the 10-year moving average of earnings adjusted for inflation. By this measure, the market looks a little expensive:

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But if we look at some other measures, such as the inflation-adjusted dividend yield or the free cash flow yield that many analysts follow, the market looks cheap. So on balance, I would say that the market’s at fair value.

Evidence from credit markets

I also look to the credit markets for forward indications of where stocks may be going. As I’ve discussed before, spreads in the bond market are the price that corporations have to pay for credit. We’ve seen those spreads stay steady or even narrow. My colleagues at MFS are experts in the credit sector, and our high-grade and high-yield bond analysts and portfolio managers are telling me that these markets are signaling better times ahead.

So to those who claim that the easy money from the US Federal Reserve is propelling equities beyond reasonable pricing, I would respond that the market at this point is not overvalued due to excess liquidity — especially good news now that the Fed’s communications have become a bit more hawkish than we might have expected. And narrower credit spreads, as we’re seeing now, have tended to be pretty good indicators when other risky assets — like stocks — aren’t under pressure.

Article by James Swanson, Chief Investment Strategist, MFS

Standing Out From The Crowd

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We were not surprised to see European equities perform strongly in 2013. Valuations started 2013 at very low levels and, with Mario Draghi, President of the European Central Bank, committed to returning stability, investors allocated to equities again at the expense of their bond holdings – a theme that we expect to continue until interest rates return to more normal levels.

It is important to recognise, however, that the upwards move in markets in 2013 was driven largely by sentiment, in anticipation of faster growth in corporate profits for 2014. Companies now need to meet these expectations, with improving earnings acting as a catalyst to further share price gains, or there could be repercussions for European equities.

Improvements in the global economy are cause for optimism, but it is probably fair to expect a higher level of share price volatility in 2014. Indeed we have already seen evidence of this in the first three months of the year, with two stockmarket falls of over 5.0%, prompted by broadly disappointing results for the fourth quarter of 2013, US tapering-induced emerging market fears and, most recently, concerns over the Ukraine.

While stockmarket volatility and political uncertainty are not welcomed by investors they provide a good opportunity for long/short strategies – funds that are designed to make money from markets that go down as well as those that go up, although returns are not guaranteed. Long/short funds can quickly reduce their net exposure to equity markets, which can help to preserve client capital when markets are falling. Equally, when fear looks overdone, they can increase their exposure to individual stocks and subsequently benefit from any market rises.

Of the risks themselves, the developments in the Ukraine are clearly the most immediate. Economically, it makes no sense for either Russia or the West to allow the conflict to escalate. Putin has seen the Rouble depreciate considerably and the Russian equity market tumble. Equally, Germany is still thirsty for Russian energy supplies and will not want to risk the fragile recovery that is coming through in Europe.

A lesser-discussed, but equally important, factor for fund returns is stock pricing correlations. Following the global financial crisis, there was very little dispersion in price movements, indicating that investors were buying or selling primarily in response to macroeconomic news, rather than company fundamentals. Yet 2013 saw stock pricing dispersion notably higher, increasing the focus on the qualities or shortcomings of individual firms. And with correlations thus far remaining low in 2014, this supports our belief that stock selection will remain critical to generating a positive return for investors this year.

Léopold Arminjon, portfolio manager of the Henderson Horizon Pan European Alpha fund