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Star managers warn over rush into Europe

01 April 2014

Investec’s Alastair Mundy and Ruffer’s Steve Russell say investors who are upping their exposure to the continent in a bid to take advantage of bargain stocks will soon find out valuations are low for a reason.

By Alex Paget,

Reporter, FE Trustnet

Investors are becoming overly complacent about the strength of the European recovery, according to star managers Alastair Mundy and Steve Russell, with the latter warning that the region is heading towards a “deflationary trap”.

Having been the perennial source of bad news for global markets in the period after the financial crisis, the European economy has begun to show signs of recovery.

As a result many investors have increased their weighting to the region over the past 12 months, but Russell warns they are being over-hasty.

“We are still very concerned about events in the eurozone. We don’t think the crisis has gone away,” Russell said.

“I think investors have become incredibly complacent. The huge volumes of money coming out of the US and going into Europe show that a lot of the concerns are gone. Europe is expected to follow the path of the US, but I’m not so sure.”

Sentiment has become increasingly bullish towards European equities with many fund managers – such as Threadneedle’s Stephen Thornberbuilding up overweight positions in the region.

Those who have had exposure to Europe have been well-rewarded as well. According to FE Analytics, since ECB President Mario Draghi told the market in the summer of 2012 that he would do “whatever it takes” to save the eurozone the MSCI Europe ex UK index has returned more than 50 per cent, which is more than both the FTSE All Share and the S&P 500.

Performance of indices since July 2012


Source: FE Analytics

However, Mundy, manager of the Investec UK Special Situations fund, agrees with Russell that investors are becoming complacent.

He takes particular issue with those who have been building up exposure to peripheral economies such as Portugal, Greece, Italy and Spain as he says those markets are still far too weak to justify the current levels of positive sentiment.

“I keep hearing people saying that that there is more certainty in Europe. To us, it looks like things are just as uncertain as they were,” Mundy said.

“Debt to GDP as a percentage in Spain and Greece is higher than it was five years ago because GDP has been flat. Also, we still think it is possible that banks have a lot of nasty loans on their books which haven’t been written off yet.”

“I don’t quite understand why people are relaxed about it now. I know there is some economic growth, but we would say it is very fragile.”

There are, however, plenty of people who disagree with that view.

For instance, FE Alpha Manager Barry Norris recently told FE Trustnet that he had been upping his exposure to Greek equities, such as some of the country’s banks, for the first time since 2006 because all of the economies’ bad news “was in the rear-view mirror”.

The MSCI Greece index has, for instance, returned a staggering 42 per cent over the last 12 months.

Bulls on the region also say that Draghi’s “do whatever it takes” speech provided a floor to equity markets and ended the chance of the eurozone disintegrating. However, Mundy (pictured) says that is a very naïve assumption.

ALT_TAG “If you’re a country with a huge amount of debt, I don’t know what Draghi is going to do for you,” Mundy said.

“That’s what interests me; five years ago people said you can’t touch Greece or Spain because those countries are effectively bust. Now, they have even more debt than they had before, but people are going back in.”

“It’s almost like everyone wants to be invested and are looking around for what has lagged to see where there could be a little bit of value left. It doesn’t strike me as low risk value.”

The other major headwind facing Europe, according to the region’s sceptics, is that it is heading towards a debt deflation spiral.

Despite central bank’s best efforts, the economies such as the US and the UK are witnessing a period of disinflation. However, recent data showed that annual inflation in the eurozone fell to just 0.5 per cent, down from 1.7 per cent this time last year.

Scott McGlashan, manager of the JOHCM Japan fund, warns that European markets are facing a Japanese-style “lost decade” of deflation as not only is there a huge amount of debt still in the system, but demographics are far from supportive.

“Europe is where Japan was in the late 1990s and early 2000s. It has gone through a stocks and shares bubble, and as well as that it’s suffering from very poor demographics.”

“If you look at why there was two lost decades in Japan, it was because demographics were so poor. In Europe, demographics are worse than a lot of people think, and that could be contributing to the worries over deflation.”

“In Japan they got the extra workforce by outsourcing to China, but that weighed heavily on domestic growth. It will be interesting to see what pans out in Europe.”

Between 2000 and 2010, when deflation crippled the economy, the Nikkei index lost close to 30 per cent.

Performance of index Jan 2000 to Dec 2010


Source: FE Analytics

Steve Russell says that the threat of deflation could reignite the eurozone crisis as governments in the periphery will be unable to erode the substantial amount of debt that is still sitting on their balance sheets.

Central banks such as the US Federal Reserve, Bank of Japan and Bank of England have all pursued a policy quantitative easing – printing money to buy up their own countries government bonds – to stave off deflation.

However, given the political and economic make-up of the eurozone and the EU, Jim Leaviss, manager of the M&G Global Macro Bond fund, says this the ECB may well be unable to follow suit.

“The risk of deflation has become an increasing concern in the Eurozone,” Leaviss said.

“In terms of a possible policy response from the ECB, a QE programme like those undertaken in the US or Japan appears unlikely. ECB President Mario Draghi confirmed at the World Economic Forum in January that the legality of this activity within EU law has been brought into question.”

“I would therefore expect to see another interest rate cut or renewed action to stimulate lending by the ECB similar to its previous long-term refinancing operations (LTROs),” he added.


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