To say the European situation looks bad is an understatement, but it would benefit investors to remember that in the Keynesian beauty pageant, it’s not about how things look right now, it’s about how other investors expect things will look in the future.
Author : Nick Tay
Wherefore Hope For Funds In Europe
Global GDP is forecasted to be sluggish, particularly in Europe
With a weakened EUR, European exports are now more competitive versus USD and JPY exports
While there are signs of improvement in stronger Euro economies, the picture is mixed for peripheral economies, which dampens sentiment on stronger economies
Wherefore Hope For Funds In Europe
By now (if not earlier), everyone knows the situation in Europe is likely to get worse before it gets better. Just look at the following chart of 2012 GDP estimates from DB Research. Of the largest economies in the world, nearly all Eurozone countries are forecasted to see negative 2012 GDP growth.
To say the situation looks bad is an understatement, but it would benefit investors to remember that in the Keynesian beauty pageant, it’s not about how things look right now, it’s about how other investors expect things will look in the future. In other words, focusing on the current situation could very well blind investors to potential opportunities for winning investments.
The worst case scenario gives us a sense of perspective into what could happenif things go badly. We’re not saying this is how things will happen, or, even if the worst happens, this is how things will turn out – we’re just getting a perspective for expectations of how a worst case scenario could potentially play out. The purpose of this exercise is to define some mental boundaries to avoid the mental paralysis that often accompanies many forecasted doomsday scenarios/end of civilization/return to barter trade etc.
A Worst Case Scenario
One possible scenario would be a domino of exits from the Eurozone. Schroders Investment Management describes this in their 3Q2012 Global Market Perspective as a bearish alternative scenario to their base scenario.
The bearish scenario starts with the death of the EUR. This results in various Euro countries reverting to their original currencies, leading to an overall fall in Eurozone GDP, widespread reorganization of the financial sector, and sharp currency adjustments for various Eurozone countries. Stronger economies will see their currency strengthen against the USD, while weaker economies will see their currency fall against the USD. Globally, commodity prices, and inflation will be lower as demand slumps. (Link)
That’s the bear case, and used to illustrate how things could go wrong, but worth noting is even in the worst case scenario, economic activity will likely continue once original currencies are reinstated. This key point is important enough to restate – even if the Euro disintegrates, individual markets will find ways to profit. There will still be demand for German, French, Italian, Spanish, Portuguese products and services inside and outside of Europe.
Of course, it would be unwise, and downright reckless to plunge headfirst where angels fear to tread, and no one, save for the foolhardiest of investors, is willing to commit their money to an opportunity, without at least some support for a decent return. So against the negative backdrop of political bickering and sky high sovereign debt levels, there are a few flickers that support the idea that Europe will pull through.
Falling EUR, Rising Exports
One major economy, Japan, has struggled with a stubbornly strong yen. This has made efforts at encouraging Japanese exports all but futile. Thankfully, the EUR has shown weakness versus both the USD and the JPY in the past year, which bodes well for Euro exports.
Image credit: Yahoo! Finance
Simon Ward, Chief Economist, Henderson Global Investors, has picked up on this idea in Henderson’s August 2012 Global Snapshot, saying, “German exporters look well-placed to benefit if the global economy recovers momentum from late 2012, as tentatively suggested by monetary trends. With the euro at its weakest level against the yen since 2000, they should gain market share from Japanese competitors. Germany is more sensitive than most other major economies to emerging-world growth.” Exports alone are insufficient to make a strong case for a European recovery, since demand for exports has not shown pre-crisis strength. But, coupled with other factors, it makes for a more convincing argument. For one major European market at least, there is additional support factors.
Low Interest Rates, Support For German Economy
The market in focus is Germany, where interest rates are currently accommodative, which lends further support for a recovery in equities.
A combination of low interest rates, and weak euro are two factors working in tandem to support a recovery in equities. As noted in DWS Investments’ Global Markets Quarterly, Asoka Woehrmann, Chief Investment Officer notes, “Interest rates are low and the euro is comparatively weak. It would be unusual if this combination of events and circumstances did not become advantageous for the German domestic economy. In the absence of this, the economic and history books must be rewritten.”
He further notes, “At the root of the recession in the euro area is a lack of confidence in the ability of individual countries to achieve the necessary economic flexibility required for a monetary union of regions with divergent economic developments, and in the capability of EU institutions to manage the present crisis.” Clearly, the present crisis is not being convincingly managed. The question then is what signals need to be seen by investors to convince them the crisis is being managed. If a lack of confidence is at the root of the recession, then a show of competence in the financial system should restore the confidence needed to sustain an improvement in the crisis.
The Revival Checklist
The 3Q 2012 edition of Schroders Global Market Perspective lists a number of factors to be met to revive growth, as summarized in Table 1.
Table 1: Adapted checklist – conditions for a revival in growth
Financial sector stability?
Lending picking up?
House prices stable?
Private investment rising?
Fiscal deficit reduction plan?
Source: Schroders Global Market Perspective, Economic and Asset Allocation Views Q3 2012, Keith Wade Chief Economist, Schroders. Last accessed at http://www.schroders.com/StaticFiles/Schroders/Market%20Strategy%20And%20News/Global%20Market%20Perspective/Global-Market-Perspective-Q3-2012.pdf
From Table 1, it is clear that while some conditions are being met, it’s an uneven process, with the core Eurozone economies, in particular Germany and France, better-positioned than the weaker periphery economies. The key takeaway here is some economies in Europe are relatively better positioned, and these are where opportunities exist.
For investors watching Europe, either in anticipation of entry, exit or schadenfreude, our equity funds in the Europe incl. UK geographic region show a number of interesting opportunities.
Europe Equity Funds
A compilation of European equity funds available on our platform shows that fund managers can still do fairly well relative to the benchmark well with diligent stock picking and indepth research.
Outperformance in bold. source: iFAST compilations, in SGD terms, dividends reinvested.
From tables 1a and 1b, a few strong performers stand out our recommended fund, Allianz Eur Equity Gth Cl AT Acc EUR has put in strong performance year-to-date and as stated in its fund review tab, “Compared against funds in its category, the fund is peerless in its strength and consistency of performance. The fund’s significant outperformance of its peers and benchmark is a clear indication of strong active management, and would appeal to investors seeking exposure to the European equity region.”
Other funds that have shown strong performance include Threadneedle (Lux) Pan Euro Eq Cl AE EUR, which outperformed the benchmark from 2008 to 2011 (table 1a), and year-to-date (table 1b). The fund is also one of a handful to put in a positive 3-year annualised return of 1.74% (as at 24 August 2012) versis the DJ Stoxx 600 return of -4.98%. In a recent Pan European update, Ann Steele, Senior Fund manager with Threadneedle Investments notes, “we continue to have significant investments in overseas earners, who are feeling the twin benefits of stronger international growth and a weak euro. The market is becoming more of a stock picker’s environment after two years of high correlations between sectors; that favours our bottom-up approach.”
Despite the Eurozone crisis, companies will still continue to generate profit and service markets. And this provides opportunities for fund managers with a sound method for picking stocks. While prudence demands that all investors watch glimmers of hope with a skeptical eye, investing equally demands investors maintain hope for the future, and not let skepticism blind them when opportunities emerge.
Nick Tay is part of the Content Team in iFAST Financial Pte Ltd.
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