Asset Allocator: April 2015: Trouble ahead for Europe?

In his latest Asset Allocator post, David Stevenson looks at the warning signs within Europe as the possibility of a Grexit heats up and the UK General Election edges closer.

 The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only. Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment. Links to external websites are not operated by or affiliated with Societe Generale. While we aim to point you to useful external websites, we cannot be responsible for their content or accuracy. Societe Generale takes no responsibility for the views expressed on any external websites or any liability arising from investment decisions you may make. You should seek professional advice if any of the content of this page is unclear. 


ASSET ALLOCATOR: APRIL 2015

20/04/15- Trouble ahead for Europe?

 

This week I want to return to the recent discussion on this page about the possible direction of markets in the short to medium term. Readers will note that over the last few weeks I’ve been growing a little more pessimistic about the seeming euphoria that has beset equity markets. The FTSE 100 index has been pushing new highs and it’s clear from fund flow data that a wall of money is heading into equity funds/ETFs globally.                   

This bullish sentiment - to this observer at least - seems to jar with the obvious fact that we have arrived at a rather difficult economic moment, with global growth rates slowing down and increased political risk (not just emanating from Greece but also the UK).  

In last week’s note I issued one of my rare warnings about equity markets and this week I’d echo that by pointing to a Code Red alert issued by the consultants at an excellent firm called CheckRisk. This Bath based outfit works closely with pension funds to analyse and monitor financial risk levels, and I have a huge amount of respect for its analysis. To be fair I sometimes think Check Risk over exaggerates the possibility of market volatility – they are risk consultants afterall – but their note last week to clients I think is an excellent summary of why investors need to tread with care. 

Their Code red warning suggests “elevated levels of risk in financial markets at a time when the global economy appears to be slowing. There is a very real risk that the age old adage "sell in May and go away" comes early this year. The reasons are: 

1) Increasing risk of a drop in non-weather related consumer spending in the USA 

2) Poor results season earnings in the USA and elsewhere 

3) A slowing of the Chinese economy to 4.5% or 5% GDP versus reported numbers of 7%

4) Increasing geopolitical risks

5) Commodity price deflation continues

6) Expensive bond and equity valuations 

7) Lack of real yields 

8) Illusion of liquidity in bond markets”  

The Check Risk team quite rightly notes that May and especially June will be crunch months – OPEC meets in June, with the US Federal Reserve also likely to make its possible first move on interest rates that month. I suspect we won’t see a small increase in interest rates but I’d concur with Check Risk when they say that “markets have just got too far ahead of themselves considering the economic backdrop, deflationary forces, and geopolitical risks. 

It is time to take some risk off the table, at least in the short term. This may be a switch to less risky assets or for those that can raising cash or allowing cash to build".

If you do feel bearish and are looking for some signals to sell I’d offer the next chart – from www.highcharts.com – as food for thought. I’m growing more and more concerned that a Grexit (Greece leaving the Eurozone) is on its way and the timing for this possible exit could be determined by the long series of hefty payments due to the ECB and the IMF, outlined in the chart below. I can’t quite see how the Greek government will be able to repay the aggregate tab of nearly 2.5 billion euros by June 20th. Of course if an agreement was struck about restructuring the economy and a mutually agreed vision for the future outlined, these payments could easily be rolled over but the mood music coming from the ongoing discussions doesn’t look promising. 

Which brings us back to the UK where our general election is just weeks away now. I have no idea what impact the election will have on the direction of major stockmarket indices but I am willing to wager that over the next 3 to 6 months international investors will feel more than a little unsettled and opt for more attractive homes for their money. 

More to the point the attractiveness of the UK as a destination for new, fresh capital might begin to look a little jaded. If we’re honest it’s become something of a consensus idea here in the UK that our equities are undervalued. 

The chart below shows the relationship between the mainstream Eurozone, DJ Eurostoxx 50 index and the FTSE 100 - the UK market has very clearly underperformed.  Many investors thus conclude that the UK is cheap and should thus receive a greater allocation of investors’ money.  

 

But maybe that under performance represents a brutal reality - that prospective profits growth in the Eurozone is likely to surprise to the upside while UK blue chips are likely to struggle to maintain positive momentum?  

Analysts at Societe Generale certainly take this view - in the charts below they plot short term, medium and long term earnings growth expectation for UK equity market.

In their view "consensus expects earnings to deteriorate further in 2015. Medium and long term earnings growth expectations for UK remain near historical lows".

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

French bank’s analysts maintain that UK equities are in fact over valued and they reckon that from an asset allocation perspective, UK government bonds "offer better value.  Our proprietary risk premium model indicates that UK equity market is expensive on an absolute basis as well as relative to government bonds. While UK government bond yields are low in historical context, they offer better value relative to UK equities".  

At the moment I'd observe that this is probably still a minority view but I think that as the political risks become more obvious at the national level after the general election, UK equities might be seen to be the weak link within the developed world markets. 

But I also think we shouldn’t get too carried with my caution about the state of the global economy and markets. My hunch is that interest rates won’t rise in the UK and the US in 2015, that China will start to push aggressively for growth, and that we’re in a slowdown that will pick up speed again shortly, led by both the US and the Eurozone.

Lurking in the background is also the reality that fundamental measures that track key markets like the UK and the US aren’t that outrageously overvalued. Many asset classes are looking fair value but if corporate profits do pick up again, especially following an even bigger drop in the price of oil, we could see those valuations seem much less daunting as we head towards 2016.  

One excellent example could be dividends here in the UK. Only this week for instance Capita Asset Services released their latest dividend monitor, a widely read publication for big institutional pension funds. 

This showed that UK dividend “payouts got off to a strong start in 2015, despite apparently poor headline figures masking accelerating underlying growth. As a result, Capita has increased its 2015 forecast for headline dividends to £86.5bn, up from £86.1bn. On an underlying basis, Capita has revised its forecast up by £500m, with dividends forecast to reach £84.1bn, the highest rate of growth since 2012.” For more detail on these dividend payouts check the two charts below. 

Bottom Line 

My own bottom line is that equities, even UK equities, still remain the least of a bad bunch in a world of overpriced assets fueled by quantitative easing. Investor’s will worry about all manner of big picture issues but eventually after much predictable market turbulence they’ll retreat to those long term assets that produce the most generous robust, growing income stream. That suggests UK equities with their strong flow of dividends as a good long term defensive bet.

 

 

Source: Capita

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The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only. Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment. Links to external websites are not operated by or affiliated with Societe Generale. While we aim to point you to useful external websites, we cannot be responsible for their content or accuracy. Societe Generale takes  responsibility for the views expressed on any external websites or any liability arising from investment decisions you may make. You should seek professional advice if any of the content of this page is unclear.

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The indices referred to herein (the “Indices”) are not sponsored, approved or sold by Societe Generale. Societe Generale shall not assume any responsibility in this respect.

 

 

 


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