Today’s market environment is very tricky. Volatility is high and investors are expecting the worst: sovereign defaults in Europe, a double dip in the US and weakness in the banking sector. This has all led to severe tensions on stock markets, says Philippe Lecoq (pictured), Co-manager of European Equities and Olivier Huet, European equity fund manager at Edmond de Rothschild Asset Management. And yet the microeconomic picture contrasts sharply with the current macroeconomic situation. In Europe in particular, companies are enjoying excellent fundamentals like historically high margins, robust balance sheets and abundant liquidity…
After an upbeat performance since the autumn of 2010, economic data in the latest quarter pointed to a worrying downturn. In Europe, growth in the euro zone slowed from 0.8% to 0.2% in the second quarter and Germany’s performance even fell to 0.1% compared to 1.3% in the first quarter which itself had been revised down from 1.5%. As in the summer of 2010, investors began to focus on the risks of a possible double dip. In Europe and even in emerging countries, heads of companies expect to see further slowing in the economy but to what extent is still unsure. In 2011 and 2012, the US and Europe should see growth of less than 2%.
The euro zone is confronting distinct problems linked to sovereign debt, institutions and financial systems but their effects have all come together. Finding a solution to the sovereign debt crisis has been delayed because institutions are unprepared and not strong enough. The second Greek rescue plan has still not been satisfactorily settled. The new-look stabilisation fund, the EFSF, will probably not be up and running before the fourth quarter and its current EUR 440bn war chest would not be enough if Spain or Italy (EUR 1.8 trillion or 119% of GDP) were to need bailing out.
To date, there is still investor concern that both Italy and Spain might not honour their debt commitments. But it will take time to assess moves by the Spanish and Italian governments to reduce their public deficits. In the meantime, the ECB is the only real operational institution and its intervention on secondary markets has helped curb soaring interest rates on Italian and Spanish debt. Whatever markets might think, Italy is not Greece and it has a primary fiscal surplus. Similarly, Spain managed annualised growth of 0.7% despite cutting the public deficit in the last 12 months from 11% to 6% of GDP.
This lack of visibility immediately hit the European banking sector. Short term bank funding has become more expensive but covered bonds are still being issued and the ECB continues to guarantee liquidity in the system, including dollar funding.
Sectors with visible dividend streams like healthcare, telecoms and oil majors, offer secure shareholder returns that are largely independent of economic and market conditions. High payouts and low stock prices have resulted in average dividend yields of more than 7% and even 9% for telecoms. This compares with safe sovereign bond yields of 2% and 4.5% for European corporate bonds as a whole.