European markets: Is it time to revise portfolios?

Is it time to start shifting our portfolios towards a slightly more positive stance?

.There is now wide – if not complete – agreement that the US economy is back on the road to recovery. The downward revision of third-quarter GDP was disappointing, but the final revision of 1.8 per cent remains positive, while more recent underlying data has tended to show improvement. Last month’s non-farm payrolls were especially encouraging as employment, of course, is key. But numbers for exports, business confidence and retail sales – including automotives – were all pulling in the right direction.

China, though a more difficult market to read in terms of statistics, also appears to be stabilising. Overall economic growth has moderated, but remains at a high absolute level. There are signs that inflation is also falling, particularly in the politically and socially important area of staple food prices. This has allowed a small easing of monetary policy, the first in a fairly long period.

One result is that the competitive round of GDP downgrades that the sell-side economists were engaged in now seems to have abated. This has in turn led to the apparent bottoming of earnings downgrades that were a semi-automated knock on from the lower growth forecasts. If nothing else, having to read a bit less about possible future gloom should help calm investors’ nerves.

The overhang of eurozone sovereign debt continues to cast a shadow. But the recent successful sovereign debt auctions in Spain and Italy suggest that investors are starting to adjust to a less negative scenario than I believe the market is pricing in. At the very least, as crisis points have unfolded and successive political summits have come and gone, the issues – and the costs – are out in the open and we can draw our own conclusions.

In terms of European equities, the focus of risk is on the banks. Investors have been worried that banks could find it difficult to refinance the debt due to mature in 2012. However, the introduction of the European Central Bank’s Long-Term Refinancing Operation will allow banks access to unlimited funds at a 1 per cent coupon on three-year redemption. There has already been significant take up of the facility and in our view it seems likely to herald a turning point for Europe’s banks. Is it time to re-invest? On the negative side lies the risk of further unravelling of the eurozone. On the positive side, the banks have underperformed for two years, valuations are low and investors are generally underweight.

In my own portfolio, I am already overweight BNP Paribas, which has a high sensitivity to movements in the European stockmarket index. I regard BNP as a good quality company whose exposure to sovereign debt is adequately discounted in the current price. I have also been adding to BBVA, the Spanish bank, another good quality institution and one that will benefit from improved costs of finance as Spanish yields continue to tighten. For the most part, we have been funding exposure to the banks at the expense of Nestlé, one of last year’s strong performers.