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European recovery to accelerate this year, says Old Mutual’s Lilley

06 May 2014

The manager is looking to the periphery of Europe to generate growth in his portfolio.

By Daniel Lanyon,

Reporter, FE Trustnet

Falling bond yields, increased M&A and stronger Spanish and Italian data in point to an acceleration in the continent’s economic recovery, according to Kevin Lilley, manager of the Old Mutual European Equity fund.

The European recovery has lagged behind the UK and US in the aftermath of the financial crisis. Over the past five years the S&P 500 rose 100.71 per cent and 88.49 per cent in the FTSE 100 compared to 67.26 per cent in the MSCI Europe ex UK.

Performance of indices over 5yrs

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Source: FE Analytics

However, Lilley says that the continent is in a good state to outperform in the future, with a virtuous cycle underway.

“Growth in the Eurozone may be fragile compared with the UK, US or China but the dark days when countries as large as Spain, Italy and France were rumoured to be on the verge of corporate bankruptcy now seem a long way away, ” he said.

“The restoration of confidence in the peripheral markets is nowhere more apparent than in Spanish and Italian bond yields.”

“Borrowing costs in Italy, as measured by the 10-year bond yield, are the lowest on record, while Spanish five year notes have fallen behind their US equivalents for the first time since 2007.”

Lilley says the falls indicative the European Central Bank is readying a stimulus program similar to the Fed’s, which began tapering at the start of 2014, which will further help the European recovery.

“While the US tapers its quantitative easing programme, Mario Draghi, Chairman of the European Central Bank is hinting at credit easing.”

“Nevertheless, low bond yields, not just in the periphery but in the Eurozone as whole mean the economic virtuous circle remains intact.”

“Falling bond yields lead to lower government funding costs, which in turn allow banks to lend to businesses at more attractive rates, thus boosting economic growth.”

He also says favourable sentiment in the bond market has filtered through to equities and boosted profit forecasts.

“This pattern of improving asset quality is likely to be repeated with other domestic-orientated banks such as Spain’s Banco Popular Espanol and Caixa Bank. It is not just earnings growth in the banking sector which is increasing.”

This is particularly evident in an upsurge mergers and acquisitions activity, Lilley says.

“Significant bid activity in Europe - GE’s $13.5bn agreed takeover of Alstom’s energy business is testimony to the view that companies believe European assets continue to represent fair value.


“The French government’s lack of opposition to the Alstom bid reflects a more pro-business attitude on the part of the Socialist government.”

“The recent mergers of Swiss cement company Holcim with French group Lafarge and the merger of advertising firms Publicis and Omnicom might not have even been allowed under Sarkozy’s right-wing presidency.”

Lilley believes the recent data from Spain and Italy show the two countries have withstood their painful healing process and are returning to growth.

“Spain has recorded its fastest pick-up in economic activity in six quarters for the three months ending March 2014 and is forecast to grow by 0.9 per cent in real terms for 2014, according to the International Monetary Fund.”

“Italian real Gross Domestic Product is set to rise by 0.6 per cent over the same period, with the possibility of further upgrades for the two countries.”

“Italian consumer confidence for April also jumped to its highest level since January 2010, while Spain continues to reap the benefits of its employment reforms.”

Alongside the upturn in economic activity and consumer confidence, Lilley says the two countries are taking an export boost from falling labour costs.

“Spanish unit labour costs fell by 7.2 per cent over the period 2009 to 2013. In Greece the decline is even more noticeable – 13.3 per cent over the same period. Contrast this with Germany where unit labour costs have risen by 5.1 per cent over the last five years.”

“The decline in Spanish labour costs has had a marked effect on exports. France’s Peugeot and Renault and Germany’s Volkswagen have all increased their automotive manufacturing capacity in Spain, making cars one of Spain’s biggest exports.”

FE Alpha Manager Cedric de Fonclare is more bearish on the European periphery than Lilley and says investors are risking capital by buying into periphery stocks that have fallen far in recent years.

He says current valuations price in a speedy recovery which he thinks is unlikely to materialise.

Lilley manages the £67.9m Old Mutual European Equity fund ex UK fund. It has returned 22.26 per cent beating its IMA Europe ex UK sector average over three years. Its benchmark – the MSCI Europe ex UK – rose 16.5 per cent over the same period.

Performance of fund, sector and benchmark over 3yrs


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Source: FE Analytics

Despite the manager’s sanguine view on Europe, he says there are downside risks to the recovery.


“The strength of the euro, particularly against the dollar and emerging market currencies, is now being cited as one of the main headwinds in corporate announcements.”

“Deflation not inflation is becoming more widely used in economic circles, although this should not be a problem. Draghi will make sure if he believes that there’s too much slack in the economy, measures will be taken to reverse this trend.”

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