‘Value’ stocks a powerful driver
Rising yields on capital may be a good driver of price returns
The UK equity market has see-sawed between falls on renewed eurozone debt worries and rises as positive US corporate results have occasionally revived appetite for risk.
Voters in the Netherlands and in France are joining the markets in a clarion call against the political leaders behind austerity, pushing Brussels towards considering additional government spending and contemplating a looser adherence to the EU fiscal framework. Unless the Germans concur, this is unlikely to be convincing.
It is this pervasive sense of a rolling crisis without resolution in Europe that is keeping the valuations of UK-listed defensive growth stocks high, and we continue to seek opportunities in stocks where the stability and sustainability of the businesses’ earnings power is undervalued. If US growth stalls, this will add to the downward pressure on growth in the eurozone.
There is no endogenous growth in Europe at present. Unemployment has surged as private demand is too weak to create jobs. Although the headline numbers on eurozone bank lending are less calamitous than markets expected, credit is only reaching stronger German and Scandinavian corporates.
The divergence between money supply and credit is an obvious concern (the ECB held interest rates at 1 per cent and inflation was a touch higher at 2.6 per cent), though not unexpected given weak growth prospects. All the European PMI reports (manufacturing and services) came in below expectations in April. The eurozone composite PMI dropped from 49.1 to 46.7, reversing the gain at the start of the year.
Together with the second long term refinancing operation boost, a positive view on US growth has been the source of much upside in the UK equity market. As the former fades and confidence in the latter ebb, our expectation of a tougher quarter for equities is being fulfilled. We are still constructive on the outlook for equities and anticipate adding to risk on the dips from our current positioning.
Although the US economic data is no longer positively surprising the equity market, we believe the economy is gradually improving. The bigger question for stockmarkets and our positioning is whether the post-crisis trading pattern is ending. Monetary largesse, developing market growth and US corporate performance has been a heady combination that has seen the S&P 500 roughly double since 2009. Corporate profit margins are one of the most mean reverting indicators in markets – it is just not possible for company earnings to grow by three times their sales line indefinitely.
We don’t expect a rapid fall in corporate profitability. However, we are wary of the industrial cyclicals where share price performance has been strong.