Throughout 2014, institutional investors have become more concentrated in their positioning. The consensus became to be underweight the euro, long the US dollar, overweight US equities and short commodity currencies. We have recently backed away from this consensus.
Last year, European equities underperformed US equities, the sixth of the last seven years in which they did so.
The negligible positive return they recorded in 2014 (+4%) reflected the lack of earnings growth.
Currently, there is a fascinating spectrum of opinions on Europe within the active management community with most gravitating to one of two opposing outlooks. Sceptics argue that European QE is doomed to fail: ‘too little, too late’. On the other end of the spectrum we see enthusiasts cautiously hailing QE in combination with lower energy and commodity prices as the saviour of Eurozone lending and spending.
A careful analysis of active managers’ portfolios reveals that almost all exhibit a well ingrained quality bias in their holdings.
Until recently, this has been warranted as European defensives have outperformed European cyclicals (ex-financials). The relative measure of this has exceeded one standard deviation.
(click on graph to enlarge) Source: Bloomberg
As is often the case, internal equity market dynamics tend to shift before macro data. On a more granular level we have recently seen a tick up in earnings of European cyclicals. Valuations in the sector are still priced for recession and reflect little optimism toward looser monetary policy, lower commodity prices and a weaker currency.
It is interesting to note that this divergence is reversed in the US, due to polar opposite expectations with regards to economic outcomes.
(click on graph to enlarge) Source: Bloomberg
In summary, the question to be asked right now is whether relative expectations, between the US and Europe and between defensives and cyclicals, have become too extreme and, if so, how to respond.
We believe that they have.
To our minds, the best way to invest in cyclical themes is through passive trackers. Few active managers have the stomach to consistently express entirely cyclical positions. It is too much of a roller coaster and carries with it considerable career risk. For those reasons we favour sector trackers and this is a good example of how an active allocator deploys ETFs.
Throughout 2014, institutional investors have become more concentrated in their positioning. The consensus became to be underweight the euro, long the US dollar, overweight US equities and short commodity currencies. We have recently backed away from this consensus.
Last year, European equities underperformed US equities, the sixth of the last seven years in which they did so.
The negligible positive return they recorded in 2014 (+4%) reflected the lack of earnings growth.
Currently, there is a fascinating spectrum of opinions on Europe within the active management community with most gravitating to one of two opposing outlooks. Sceptics argue that European QE is doomed to fail: ‘too little, too late’. On the other end of the spectrum we see enthusiasts cautiously hailing QE in combination with lower energy and commodity prices as the saviour of Eurozone lending and spending.
A careful analysis of active managers’ portfolios reveals that almost all exhibit a well ingrained quality bias in their holdings.
Until recently, this has been warranted as European defensives have outperformed European cyclicals (ex-financials). The relative measure of this has exceeded one standard deviation.