Photo: Roberto Taddeo. Pioneer Investments Organizes an Exclusive Due Diligence Event for Morgan Stanley and UBS Advisors
Pioneer Investments will hold an exclusive Due Diligence international forum in Dublin from the 20th to the 22nd of May; this year’s forum is entitled “Navigating Uncertainty via Innovative Thought”. The event, which is aimed at 85 Morgan Stanley and UBS Wealth Management financial advisors, will be hosted by Pioneer Investments’ Senior Investment Team and will feature prominent speakers who will explore the challenges and opportunities within the current changing context.
In particular, Pioneer experts will discuss the following topics:
How central banks are changing our world
Preparing for lower returns and higher volatility
Identifying new investment solutions
New trends in product and asset management
Main highlights on the agenda include a presentation by Adrian Furnham titled: “Debunking the Myth that Intelligence is Gender-Based “. The forum will also be attended by Nigel Gifford, whose presentation is titled: “Game of Drones: Ascenta” and Ricardo Baretzky, who will talk about cyber attacks and cyber terrorism risk management.
Photo: Glenn Beltz. Oil & Gas: The Cashflow Conundrum
With the oil price declining steeply during the fourth quarter of 2014, the prospects for dividends from oil companies are worth special attention. Though they rose 5.8% in 2014 to $134.1bn, according to the Henderson Global Dividend Index (HGDI), making this the second largest dividend-paying industry, there are question marks over the sustainability of their dividends going forward, as lower prices feed into lower profits.
We believe the oil and gas sector is likely to be challenged in terms of growing dividends for the next few years. Oil service companies such as Seadrill and Fugro have already cut their dividends and with further cuts to capital expenditure likely from oil majors, more of their peers may also cut.
The big oil producers themselves, which account for around three quarters of the sector’s dividend payments, should be able to hold dividends for a while as their balance sheets are strong. However, if the oil price does not meaningfully recover over the next couple of years then cashflow will not be strong enough to allow for required investment and dividends.
In the shorter term the oil majors are likely to prefer to allow dividend cover (the ratio of a company’s earnings over the dividend paid) to fall by paying out a larger percentage of their profits rather cutting the dividend they pay. Royal Dutch Shell is commonly the largest dividend payer in the world (though it was beaten in 2014 by Vodafone). Royal Dutch Shell has not cut its dividend since World War II, despite wide swings in the price of oil since then. French multinational oil and gas company, Total (ranking 17th in terms of top dividend-paying companies in 2014) has not cut its dividend for 40 years.
Emerging market cuts
Companies in Emerging Markets are more likely to cut given fewer opportunities to cut capital expenditure and weaker balance sheets. The fall in the price of oil is a key factor influencing our decision to reduce our expectations for overall dividend growth from Emerging Markets, where dividends from oil companies account for 26% of the region’s total, around twice their share in global markets overall.
Fund exposure
The fund’s exposure to the oil & gas sector is currently low at 2.9%, versus 6.7% of the index. This is due to concerns over cashflow growth and the ability to grow dividends. With the significant fall in the oil price over the last six months this position has aided performance on a relative basis.
Andrew Jones is member of the Henderson Global Equity Income Team
CC-BY-SA-2.0, FlickrPhoto: Cabeza de Turco. Thumbs Up for Equities, Avoiding the US and Emerging Markets
Global equity markets remained in an ebullient mood in February, with the MSCI World index producing a US dollar total return of 5.9%. In the US, the S&P 500 broke through a series of record highs (although it has subsequently given up a little ground in March) while in the UK the FTSE 100 finally eclipsed its previous all-time closing high of 6930 (set in late 1999), finishing the month at 6946.7. European, Japanese, Asian and emerging market (EM) equities also made strong progress in local currency terms.
In contrast to the strength seen in equity markets, US and UK government bonds had a difficult month, with the yield on the benchmark US 10-year treasury climbing from 1.64% at the end of January to 1.99% at the end of February. The broad UK gilt market registered a sterling total return loss of -4.2%, with long gilts (-7.6%) performing particularly poorly. European core bond markets were largely insulated from these moves, with the 10-year bund yield finishing the month at 0.3%. At the time of writing, yields on a number of short-dated European government bonds are negative, and Swiss government bonds offer negative yields out to 10 years.
In equity markets, we are positive on all the major regions except the US, where we have a neutral weighting in our asset allocation model, and emerging markets, which we continue to underweight. In our view, the US is undoubtedly the strongest of the developed world economies and is home to a range of world leaders across a range of sectors, and we continue to find interesting long-term stock-level opportunities in areas with exciting growth potential, such as immunology. For the broader market, however, valuations are less compelling and we continue to believe that a strengthening dollar is likely to provide a headwind for US multinationals.
EM equities trade at a significant discount to developed markets and there are good opportunities in the countries that are beneficiaries of lower oil prices and where the respective governments have committed to business-friendly reforms. Unfortunately, commodity-exporting EMs, such as Brazil, remain under pressure, and similarly the low oil price is a headache for a range of EM oil exporters with knock-on adverse effects for their currencies.
In Asia ex Japan, valuations are attractive versus other markets and in Japan itself we expect a weaker yen to provide a significant tailwind for corporate earnings this year. UK equities have been the focus of some of our asset allocation meetings over the past month, and despite the broader re-rating of the market, our UK team continues tofind companies that are committed to boosting shareholder returns. The UK also remains an M&A target, due to the relative ease of the takeover process, and the market’s high dividend yield is still attractive in a global context.
In bond markets, we see an increasing disconnect between the US and UK, where yields should move higher, and Europe, where the ECB began intervening in secondary markets on 9 March. Previous episodes of QE have been a case of ‘buy the rumour, sell the fact’ when it came to rates markets, but for Europe we think that the sheer scale of the ECB purchases will be positive for markets from here. This appears to be borne out by price action; as I write, 10-year bund yields have declined further to just 0.2%. A second-order effect of the ECB’s policy is that many non-euro corporate issuers are tapping European bond markets due to the very cheap financing that is available; one estimate suggests that of the €37.8 billion of investment grade non-financial issuance that was seen in February, some €30.8 billion of this was from companies that are incorporated outside the eurozone!
For bond markets more broadly, the next major catalyst could come in the form of the Fed; any change in its language is likely to be seen as laying the ground for a rate rise, although the strong dollar and low oil prices suggest that the broad CPI readings are likely to remain subdued, meaning there is no obvious rush to raise rates. The recent strength in labour markets will provide food for thought for the Fed however, and we will be watching developments closely in the coming weeks.
Column by Mark Burgess, CIO at Threadneedle Investments
Foto: Petar Milošević (Own work). Santander AM Reaches €12.4 Billion in Assets in its Range of Profiled Funds
Santander Asset Management (SAM), a global company dedicated to managing assets internationally and 50% owned by Banco Santander and 50% by Warburg Pincus and General Atlantic, has attracted a total of 6.169 billion euros to its range of profiled funds, which are aimed at customers in the Banco Santander Select and private banking segments, representing 99% growth, in the last twelve months. As such, assets managed in these products were around 12.388 billion euros by the end of February while the number of Bank customers holding exceeded 220,000.
Profiled funds include Select, which combines the bulk of assets in this range of funds, along with private banking profiled funds in Spain (Santander PB Portfolio), Portugal (Santander Private), Chile (Santander Private Banking) and Mexico (Santander Elite). The Select range of funds, which has already been exported to eight countries, is a global investment solution aimed at adapting to both different market environments and each local customer’s risk profile. Select profiled funds invest in a very broad universe of assets, selected through suitable asset allocation, providing access to the best domestic and international asset managers and allowing for dynamic investment management and rapid adjustment of positions based on each scenario.
The Spanish market has seen the greatest growth in this period, after increasing assets under management of 4.355 billion euros and reaching 7.213 billion euros, representing a 152% increase compared to March 2014. The Santander Select Prudent fund is notable, with assets reaching 3.449 billion euros, as is the Santander Select Moderate fund with 2.546billion euros. In Mexico, the Santander Asset Management profiled funds together total 1.073 million euros (the Santander Select Conservative fund has been the most popular offering, making up 350 million euros) after growing 92%, while 459 million euros have been reached in Chile (84% growth) with Santander Select Prudent being the largest at 226 million euros. Germany has recorded a 558 million euro volume (+80%) and Brazil 82 million euros (+91%). Assets are around 2.262 billion euros in the United Kingdom.
The Select fund range was launched in Spain at the end of 2010. The range was launched in Chile and Mexico in 2011 and 2012 respectively while they have been sold in Brazil and Germany since 2013. The most recent launches took place in 2014 in Portugal and Poland, with great commercial success in both countries with assets of 537 million euros and 206 million euros, respectively.
The three risk profiles on which the Select range relies (Prudent, Moderate and Determined/Dynamic) each investor the profile choice that best suits their needs and risk tolerance levels. The Prudent fund, aimed at more conservative investors, represents 42% of the total Select range assets. The Moderate fund, which have a greater weight in equity, represents 39% while the Determined/Dynamic fund, which has a more risk tolerant profile, represents 19%.
CC-BY-SA-2.0, FlickrPhoto: Pedro Layant. Serbia: Now, It’s All About Walking the Talk!
In February 2015, Global Evolution visited Serbia for an extensive due diligence. Significant fiscal disappointments over the last year were recently reversed with prudent fiscal policy reforms in the context of a new IMF program.
However, the persistent recession and the unappealing business climate were key worries that Global Evolution addressed during the trip. It is now all about walking the talk – i.e. actually implementing the plan; with institutional capacity constraints being the main worry for the team!
Ahead of the trip, the investment management team conducted in-depth review of the Serbian economy through video- conference with the World Bank Mission Chief; and a pre-trip Debt Sustainability Analysis (DSA) was prepared to generate preliminary guidance to its investment process. During the trip the experts of the firm met with the National bank of Serbia, EBRD, Ministry of Finance, the Fiscal Council and the World Bank.
Fiscal anchor established with IMF precautionary program
Serbia is facing serious fiscal imbalances, and protracted structural challenges. The new government appointed in 2014 has a window of opportunity to address these issues, with support from a new IMF program. Strong fiscal consolidation over the program period – largely based on curbing mandatory spending and reducing state aid to state-owned enterprises (SOEs) – is needed to put public debt on a downward path.
In terms of program modalities, the IMF program supports the authorities’ medium-term policy goals to restore fiscal sustainability, bolster growth, and boost financial sector resilience by providing a precautionary 36-month Stand-By Arrangement with access of €1,122 million.
“We concur with the Serbian authorities and the IMF that the program will underpin Serbia’s resilience against adverse shocks that could give rise to a balance of payments need. The program structure is based on fiscal, monetary, financial sector, and structural reform pillars”, wrote Global Evolution in its reserch.
“The nominal reductions already legislated on – and budgeted with – with regard to wage levels and structures and pensions reforms combined with the real reduction coming from natural downsizing of the public sector labor force is likely to generate the required fiscal consolidation and we expect the government to strenuously follow this track of fiscal pain. It is now all about implementation which is challenged!”, continued the analisys.
The debt sustainability issue is also key for Serbia and the few- days-old IMF DSA reveals a flattening of the debt/GDP trajectory by 2016-2017 after which numbers start slowly improving. The debt/GDP ratio peaks in 2018 at 78.4% – a level that we see being rather optimistic.
“We believe that the number will exceed 80% and that the downward turn in the trajectory will last more than just to the end of 2016; rather we expect two more years of program implementation time for the consolidation process to be completed due to weak institutional capacity. But we categorize the degree of debt sustainability as Moderate since no dire threat to sustainability is present despite elevated levels”, point out Ole Hagen Jorgensen, research director at Global Evolution.
“The lack of institutional capacity is, in our view, a key obstacle to implementing the fiscal consolidation and structural reform program. With a reduction in the quantity of public sector human resources, an uplift in the quality should compensate. This is likely to be a very slow process, but the World Bank is supporting the Government with Development Policy Loans (DPLs) to enhance wide-spread public sector management practices”, said Jorgensen.
In addition, loans have been granted but not disbursed due to severe institutional shortcomings – leading to no implementation of projects and, thus, no disbursements of already approved loans with the World Bank. For example, approximately $1bn in infrastructure financing was signed off by the World Bank, but only 8 km of highway was built so very little was disbursed; the rest was missed out on.
This is a general tendency with public sector projects and a key worry for the team- a development we will follow closely as the IMF program unfolds; thus the title of this.
Structural reform key for economic and fiscal efficiency
Broad-based structural reforms, notably to improve the business environment and resolve loss-making SOEs, should foster Serbia’s medium-term growth potential and reduce fiscal risks. There are 502 SOEs to privatize/restructure with 118 filing for bankruptcy.
“As a consequence, our view on Serbia’s outlook is that the coming 2-3 years will entail a process for paving the way for growth by fiscal and structural reform that enables growth. This will provide a platform from which growth can take off over the medium term—though expectedly not over the short term”, conclude the research.
Global Evolution, an asset management firm specialized in emerging and frontier markets debt, is represented by Capital Stragtegies in the Americas Region.
One of Japan’s most powerful lobby groups—Japan Agriculture Group Zenchu (JA Zenchu)—has effectively controlled the country’s agricultural sector from behind the scenes along with other arms of the umbrellla group, the JA Group. The other divisions include agricultural trading company Zen-noh and financial services arm No-Chu.
JA Zenchu holds extraordinary power based on Japan’s Agricultural Cooperative Law, which has long granted it the exclusive authority to “audit and advise” local farming co-operatives. It charges such co-ops a fee for services, even though some say their advice is useless, and the funds have frequently been used in turn to peddle political influence. If you’ve ever wondered why Japan has maintained extremely high import duties for agricultural products, JA Zenchu has a lot to do with this.
For decades, JA Zenchu has been a reliable vote-gathering machine for the ruling Liberal Democratic Party (LDP), a major driving force that has kept the LDP in power for most of the post-World War II era. However, last month, Prime Minister Shinzo Abe announced that JA Zenchu (grudgingly) accepted his proposed changes to strip the group of its exclusive “audit and advise” power. Local farming co-ops will be able to hire their own audit firms, and will no longer have to pay JA Zenchu for their advice. This will effectively dismantle JA Zenchu. Why is Prime Minister Abe trying to change a winning formula for his own party?
Japan’s agricultural sector faces a number of challenging issues like an aging farming population, and low ratio for food self-sufficiency. But the biggest problem is that the industry has been coddled for decades, protected by high import duties and government subsidies. In recent years, the percentage of products distributed through non-JA channels has increased, but still, many farmers, particularly rice and vegetable growers, have opted to sell their products exclusively through the JA Group instead of building their own brands or sales channel. In fact, in some cases JA Group has discouraged entrepreneurship as it feared that might undermine its influence and control. However, ongoing negotiations for the Trans-Pacific Partnership are expected to lower import duties for many agricultural products exposing farmers to competition that they are ill-prepared to face. Removing the shackles of JA Zenchu is the first step to liberalizing Japan’s farming sector, and allowing the sector to attract capital and talent that could drive innovation and productivity.
Frankly, liberalizing the country’s farming industries is a daunting challenge. Agriculture is unpopular among the younger generation for its notoriously harsh labor requirements. For the same low pay, there are far easier jobs to be had. Institutionalized farming corporations account for less than 7% of total farmland area. I wouldn’t bet on a revival of Japanese farming at this point. Still, you have to start somewhere, and dismantling a major lobby group that has stood in the way of entrepreneurialism is a good place to start. At least, it shows that there are no sacred cows when it comes to structural reforms. Another third arrow has been fired.
Kenichi Amaki is 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.
Photo: Mark Fischer. EM’s Diverging Universe: Opportunities and Risks
2015 is definitely not the year to be making general statements about emerging markets (EM). The EM asset class is made up of a diverse mix of credits with varying risk and reward prospects, and the fortunes of the various economies within EM are currently increasingly diverging. There is a particular contrast between commodity exporting and commodity importing countries. Additionally in emerging Asia, there are different dynamics between commodity importers and manufacturers. The shifting dynamics make active management and fundamental research particularly important. For the selective strategy, EM credit currently offers a compelling investment case with certain countries attractive on valuation and fundamental grounds, others presenting tactical opportunities, while some markets are best avoided.
Expanding divergence
A high level look across the EM universe demonstrates the dynamics currently at work:
Asia is changing. Asian countries are increasingly becoming consumption-driven, shifting from their manufacturing-dominated economic status of the past; innovations in e-commerce are driving growth while demographics silently act as a further catalyst. The trends, while well-rehearsed, are ever important and are set to continue for a number of years. Meanwhile lower oil and commodity prices will work to the benefit of importing countries, such as India and China. The strong reform agenda pursued by India strengthens the country’s prospects while China is slowly becoming increasingly consumer-driven.
Latin American economies are on a different path; their pace of growth has now generally slowed and will likely continue at sub-par levels. Hurt by weakening commodity prices and the strength of the US dollar, their depreciating currencies present challenges. Additionally, the desire to raise interest rates to control inflation is a dilemma for many given the need to simultaneously stimulate growth.
Elsewhere, growth is weakening in Central and Eastern Europe, despite some signs of resilience in domestic demand. With Russia in recession and likely to remain there at least for the next two years, countries with currencies directly linked to the euro will continue to suffer but will have some insulation with the support of the European Central Bank’s quantitative easing programme.
Technical and fundamental support
While certain macro and geopolitical risks remain, there is currently strong support for a constructive stance on EM.
Technical factors are positive
With government bond yields close to all-time lows and in some cases in negative territory, there is strengthening demand for corporate bonds (credit) and higher yielding assets around the globe. Chart 1 shows there are now close to €1.2tn of negative yielding assets globally and the levels of assets within various other sectors, including EM sub sectors. This implies a lengthy, more protracted multi-year environment of searching for yield and diversification, with EM a likely beneficiary.
For investors seeking additional compensation, chart 2 shows the balance of risk and reward of moving down the credit spectrum, which markets can offer higher yields and how liquid those markets are. Each bubble represents the total volume of outstanding issues within the particular sector.
Notably, the US dollar-denominated EM corporate bond market has grown significantly in recent years and the depth that this provides makes an allocation to this asset class within a portfolio potentially attractive. While the demand continues, there will, of course, be intermittent periods of volatility in this extended credit cycle as more investors are crowded into the same markets. We believe it will therefore be increasingly important to have a sharp ‘credit picking’ focus with the current environment of more credit rating downgrades than upgrades in EM set to continue.
The expected rise in demand for higher yielding assets corresponds with a time of reduced supplies in EM, with big issuing countries such as Russia and Brazil, finding it difficult to issue new debt. While investors shy away from Brazil on macroeconomic concerns, Russia faces a list of financial headaches. These include currency weakness and a looming recession as the country absorbs the double blow of Western sanctions over Ukraine and the sharp decline in the oil price since June 2014.
For euro investors there is, however, likely to be more euro-denominated issuance in EM credit, which should meet demand. On the flip-side, this would detract supply for dollar investors. A further supporting factor is the momentum gathering in the pace of inflows into EM external debt markets. This again is chasing a limited pool of securities relative to the scale of the demand and should therefore buoy prices.
Valuations favour EM
In many areas EM valuations are attractive relative to markets outside the sector. For example, on a 5-year historical basis, EM high yield credit is more attractively valued than US or European high yield.
Putting divergence to work
The current themes in our portfolio reflect the differentiation in EM and that we see this as a fundamentals-driven market. While headwinds remain at a macroeconomic level, fundamentals are improving for certain sectors and names. Careful selection between countries, sectors and stocks should therefore make a marked difference to overall returns.
Chinese overweight: The biggest overweight in the portfolio is China. This weighting is a result of credit specific opportunities, particularly within state-owned enterprises, infrastructure and quasi-sovereigns such as the ICBC, where we hold the subordinated additional tier 1 (AT1) perpetual bonds issued in October 2014.
Brazil/Mexico – macro challenges but credit specific opportunities: In Brazil there are a number of companies that are attractive from a valuation perspective. We have overweight positions in oil and gas and infrastructure (Petrobras and Odebrecht), and the ‘protein sector’ (meat and poultry). The latter is one of the biggest export markets for Brazil. In Mexico, the chemicals sector is attractive, although selectivity is required given the impact of overcrowding and valuations becoming rather rich.
Russia – look beyond the headlines: Russia is still interesting from a technical point of view and also on valuation grounds. However, we are highly selective in our approach. Favoured names include Gazprom, Lukoil and VimpelCom; the latter is a strong cash generative business, which is also buying back its bonds.
Markets currently to avoid: At the opposite end, there are areas that we do not favour on fundamental grounds (Argentina and Venezuela), while valuations elsewhere make investments unattractive at current levels. In Latin America these include Chile and Peru; in Asia, Thailand, Malaysia and Korea and finally in Europe, the Central and Eastern European countries.
Steve Drew is portofolio manager for Emerging Market Corporate Bond Fund. These are fund manager views at the time of writing and may differ from those of other Henderson fund managers. The information should not be construed as investment advice. Before entering into an investment agreement please consult a professional investment adviser.
Foto cedidaFoto: Tim Stevenson, manager of the Henderson Horizon Pan European Equity. Debunking the ‘growth versus value’ myth
Tuesday at 10.00 am, Christie’s New York will auction the original manuscript and notes to Don McLean’s “American Pie” -sold by the singer-songwriter-, arguably the most iconic and recognizable American song of the Twentieth Century released in 1971.
This masterpiece of American arts and letters is estimated at $1 to $1.5 million. The investor will get the 16 pages of original working manuscript and typed drafts for the song, containing 237 lines of manuscript and 26 lines of typed text.
Since debuting on the airwaves in 1971, Don McLean’s “American Pie” has stood as one of the most important icons of twentieth-century American music. The singer-songwriter’s masterpiece became the anthem of McLean’s own “generation lost in space,” and continues to resonate in the present day. The author has remained decidedly enigmatic about the meaning and messages hidden in his masterpiece; like any great work of art, he says, the song remains open to interpretation, informed by the histories and experiences of all those who encounter it.
McLean’s song describes the turbulent upheavals of the latter half of the twentieth century and it is an emblem that stands alongside the work of post-war figures such as Andy Warhol, J.D. Salinger, and Bob Dylan in its importance to the American cultural canon. The song was composed in Pennsylvania and Cold Spring, New York, recorded in May 1971 and released in October.
“I thought it would be interesting as I reach age 70 to release this work product on the song American Pie so that anyone who might be interested will learn that this song was not a parlor game. It was an indescribable photograph of America that I tried to capture in words and music,” he says. “I would say to young songwriters who are starting out to immerse yourself in beautiful music and beautiful lyrics and think about every word you say in a song,” added Don McLean.
Rock memorabilia collecting is popular among wealthy baby boomers, which are looking for alternative ways to invest, publishes bloomberg. The most sought-after manuscripts are from the Beatles and Bob Dylan, said Leila Dunbar, a former Sotheby’s executive who is a memorabilia appraiser and consultant in New York. Dylan’s “Like a Rolling Stone” sold for more than $2 million in 2012, and the Beatles’ “A Day in the Life”sold for $1.2 million in 2010. Both were sold at Sotheby’s.
The buyer is likely to end up being a private collector because museums cannot usually afford such an expensive memorabilia, and most items in the Rock and Roll Hall of Fame are donated, said Warwick Stone, a curator for the Hard Rock Hotel Las Vegas’s memorabilia collection. Chinese buyers have shown an interest in American pop culture memorabilia, particularly items from Michael Jackson and Marilyn Monroe, he said.
Photo: Moyan Brenn. Are the Green Shoots of Recovery Finally Starting to Appear in the Eurozone Region?
Cyprus is lovely this time of year. With the green shoots of spring starting to emerge from the winter months it’s a time of new beginnings. Perhaps fitting then that Mario Draghi, President of the European Central Bank (ECB), should choose the island to unveil his upgraded growth forecasts for the eurozone region. Following years of near economic stagnation, GDP growth is estimated to rise by 1.5% for this year and 1.9% for 2016, up from 1.0% and 1.5% respectively. Draghi’s key hope is that the re-appearance of growth will deflect the deflationary scare that pre-occupies markets and investors alike.
There are solid grounds for thinking those growth forecasts might be on the conservative side. The sharp decline in the oil price, the euro’s devaluation against the US dollar – over 20% at the time of writing since its peak in May 2014 – and Draghi’s attempt to reflate the eurozone’s balance sheet mean that the region has undergone seismic shifts since the beginning of the year. Shares have already priced in some of the good news. In February alone the MSCI Europe index rose by a heady 6.9% in local currency terms, although that reduces to a little over 3% in sterling terms.
The rise in eurozone cyclicals since the start of the year shows the market is already aware of the most obvious sectors to benefit from the double tailwinds of a weaker euro and oil price. Airlines, automobiles, food producers and retailers are the most obvious candidates, as well as financials and engineers. But where’s the real evidence that the green shoots of economic recovery are appearing? While the full extent of a devalued currency is yet to be fully known, export data look encouraging. According to Eurostat, the European Commission’s statistics bureau, exports for the eurozone region are up by 0.8% quarter-on-quarter. Year-on-year statistics show an impressive 4.1% for the fourth quarter ending 2014.
Yet, good news has not yet properly fed through to the analyst community. While the scribblers have been keen to downgrade the obvious company ‘victims’ – those oil majors directly hurt by Brent crude’s decline – the positives have yet to be fully reflected in earnings upgrades. This is largely due to the unquantifiable nature of by how much exactly a declining oil price and euro affect profitability. Yet, we do have some idea. According to estimates, a 10% drop in the euro (against other major currencies) could boost corporate earnings in the eurozone area by as much as 7%. That’s a very high correlation by any measure. Watch this space then, come April, when first quarter results, (especially for those companies where the cost base is in euros but sales are outside of the region) start to be unveiled.
What of the imminent headwinds for the region? Talk of a permanent deflationary spiral remains top of the list, with many investors still to be convinced that the eurozone will not follow Japan’s ‘lost decade’ period. Surplus capacity, particularly in Spain, and high levels of eurozone unemployment are still cause for concern, although Germany’s unemployment rate remains at a record low of 6.5%[2]. But signs of an improving consumer’s lot are already in evidence. This is particularly evident in the growth in European car sales – up 8% for February alone. Furthermore, real wages are increasing. IG Metall, Germany’s Industrial Union of Metalworkers, recently awarded their workers a pay rise of 3.4% – quite substantial given inflation in Germany is zero.
Of course, no one can permanently silence the bears on Europe – we’ve been used to their talk of anaemic growth and deflationary spirals for long enough. But if earnings revisions come through strongly in the spring and subsequent months, it should be sufficient to silence them for some time to come.
Kevin Lilley is portfolio manager of Old Mutual European Equity Fund, Old Mutual Global Investors
Photo: Institution for Money, Technology and Financial inclusion. EM Growth to Bottom Out in Second Half, NN Investment Partners Says
After five years of growth adjustment, the risks within the emerging markets start to look more balanced, according to Maarten-Jan Bakkum, Senior Emerging Market Strategist at NN Investment Partners (former ING IM)
Global headwinds and obstacles to growth remain, but are not getting worse. Without an accident in China, emerging market growth should bottom in Q3 or Q4. China demand slowdown is structural and continues to put pressure on the emerging markets in terms of trade, but a correction in the housing market is slowing and monetary easing has started. US monetary policy normalisation continues to put pressure on EM capital flows, but ECB QE has refuelled the global search for yield. In this context, EM central banks see room to cut interest rates.
Maarten-Jan Bakkum, Senior Emerging Market Strategist at NN IP, said: “Rapid leverage growth has created macro imbalances and system vulnerabilities, pushing policy makers into action in some countries, including: Indonesia, South Africa and Brazil. Policymakers in Indonesia in particular, stood out. Reducing macro imbalances within the country with the central bank remaining relatively prudent and president Joko Widodo’s government removing fuel subsidies and thereby creating fiscal room for infrastructure investments.”
Also, South Africa has shown better growth momentum, strong earnings growth, improving terms of trade, and the government has shown more fiscal discipline.
Bakkum continues: “Other areas that are currently showing promise, include Mexico. Mexico is one of the few markets with a positive growth momentum. Its large exposure to the US and low sensitivity to China are key positive factors making this an overweight for us.”
ING IM believes that strong earnings momentum and solid capital inflows are the main reasons to like the Philippines at the moment. Reforms and more policy discipline continue to have a positive impact on growth prospects of India, where the lower oil price helps too. Also, better economic governance and lower political risk have helped Egypt’s growth to recover to pre-2011 levels.
Easier financial conditions can compensate temporarily for the lack of structural change but EM currencies remain vulnerable. More depreciation is likely to be needed to enforce the reforms that reduce macro imbalances and create engines of future growth.
