Geopolitics, the Zika virus and the continuation of quantitative easing are just some of the macroeconomic headwinds being overshadowed by the China slowdown and plummeting oil prices, according to Hermes’ Tim Crockford.
The manager, who co-runs the Hermes Sourcecap Europe Ex UK fund alongside James Rutherford, primarily adopts a bottom-up stock selection process but also factors in underlying market themes when analysing companies.
He says that the fixation on one or two macro themes by the media and investors is actually positive for highly-active stock selectors, as asset classes with strong fundamentals also get dragged down alongside weaker assets and can be bought at more attractive valuations.
However, he warns that when one or two headwinds are focused on, other factors in the market can often end up ignored.
“There’s a lot more going on in the world than just China and oil. When you get extreme positioning in markets typically there is going to be a focus on things like China, things like oil and headline investing generally,” he said.
Performance of indices over 1yr
Source: FE Analytics
“I think the bigger picture of it is that, like many other assets classes and like many other commodities in the case of oil, we’ve had this massive money printing programme being run by so many central banks around the world.”
“I’m not the first person to say this, but the sad truth is it’s gone so far, where naturally you’ve had so much capital being thrown into projects which probably shouldn’t have been, but because the cost of capital rates has been held low we’ve seen this abnormal situation whereby money has been thrown into investments when it shouldn’t necessarily have been.”
While Crockford says that quantitative easing can be a valuable tool for creating liquidity during times of crisis, he believes it isn’t fool-proof in terms of creating economic growth.
While some investors would point out that the US, which employed a bond-buying programme in 2009 until 2014, has experienced growth, the manager questions whether the economy has grown enough considering the huge amount of money that was printed, which amounted to more than $3.5trn.
“I think the use of QE has created this extreme hunt for yield and pushed people into riskier asset classes they wouldn’t normally invest in,” he said. “As a result, the focus has been on China, the focus has been on oil and other commodities, which have been ramped up by QE.”
“It’s not surprising that you’ve had these falls. However, the great thing about market moves like this is that when asset markets fall out of bed, everything gets dragged down, and some asset classes rightly so, but some asset classes and get undervalued.”
Hermes Sourcecap Europe Ex UK, which is £188m in size, has its largest weighting in Germany at 28.93 per cent, followed by Switzerland at 13.95 per cent (nevertheless an underweight versus its FTSE World Europe ex UK benchmark), Spain at 12.59 per cent and the Netherlands at 9.96 per cent.
Despite gloomy market sentiment across the globe at the moment, Crockford is confident that there are fewer headwinds for Europe than some other developed markets.
“In terms of the US, it’s very hard to argue that the corporate profitably cycle hasn’t peaked. In fact, you could probably state the case that if you took out share buybacks, it probably peaked quite a while ago,” he continued.
Performance of indices over 3yrs
Source: FE Analytics
“You now have rising labour costs, you have an economy which is still growing but slowing down, and I think structurally America still has its problems.”
“I think more importantly, rather than what’s going wrong for the States, from the corporate profitability aspect with Europe we’ve had five years now of companies getting their balance sheets in order. You’re seeing earnings that aren’t largely being driven by share buybacks as we’ve seen in the US.”
While some investors would argue that European equities have become more expensive in recent years, Crockford says that the region is still in the early stage of the economic cycle and that it is only just starting to recover.
“Yes equity valuations are more expensive than they have been but we’re at an early stage of the cycle,” he said.
“I’m not going to argue that there are no challenges structurally facing Europe in the long term, but I think in terms of the cycle in Europe, I would definitely feel more comfortable putting my own money into European equities, specifically those with more of a bias towards the European consumer.”
Despite this, there are still a number of headwinds on a global scale that the manager is keeping a close eye on. One of which is geopolitics, which he says is something that has been a particular worry over the last two years.
The most recent geopolitical concern that he is worried about is the outbreak of the Zika virus, which causes mild fever-like symptoms and is suspected of being linked to microcephaly in new-born babies if pregnant women contract the illness.
“The worrying thing about anything geopolitical is that you can’t forecast it, it can be very volatile, it can be very hard to price in, and the only thing you can do is react to it,” he explained.
“I think out of the emerging markets, Brazil is the one that worries us the most. Of course there are a number of European companies that have exposure to Brazil.”
“Everyone expects the Olympics to give them a bit of a helping hand but actually this could change that. They’ve spent a lot of money on what is already a very stretched sovereign balance sheet. That’s definitely a theme we worry about.”
Another headwind that concerns the manager is monetary policy divergence and the increased dependence on central banker’s actions for both healthy economies and markets.
While Crockford believes that this divergence could soon change if the Fed begin loosening policy again, he says that the negative interest rate environment we’re living in is an issue for markets.
“I think the problem is, for the European banks in particular, that negative interest rates don’t help them. It’s not exactly helping lending pick up, and I think even though we’re positive about the European consumer, growth rates will probably start to slow this year, particularly because last year was good, but also because we’re not seeing any meaningful pick up in lending across the zone,” he said.
“I think just generally, I can’t ever remember a time, and neither can those that have been in the industry much longer than I have, whereby so much of what we do is driven by central bankers.”
Since Crockford joined the fund’s helm in 2014, Hermes Sourcecap Europe Ex UK has provided a total return of 0.9 per cent compared to its sector average’s return of 1.65 per cent.
Performance of fund vs sector under Crockford
Source: FE Analytics
It has a clean ongoing charges figure of 0.88 per cent.
