European equity markets hit hard by Dollar depreciation

BY PAOLO MARONGIU

Monthly Fund Commentary
21 Sep 2017

BY PAOLO MARONGIU

​The European stock market rebounded in the first eight days of August, followed by two corrections – a short-lived correction around the middle of the month and a subsequent longer-lasting decline. The last two days of the month saw a strong revival, taking the MSCI Europe Index back to 126.

Overall, the month however ended with a small decline in performance (-1.06%), but with a steep increase of the European Equity Volatility Index. The latter surged three times throughout the month, reaching the value of 19. The monthly moving range for the MSCI Europe was nevertheless still smaller than in July: The index hit its monthly high at 129.25 and posted its monthly low at 124.40.

In August, the European market slightly underperformed (in Euro terms) the S&P 500 and the MSCI World Index. At the same time, it strongly underperformed the MSCI Emerging Markets Index, which posted a large gain both in local currency and in Euro terms. The American stock market is still near its year and historical high (around the 2500 mark) and overall shows good resilience. Throughout the month, a correction took place, for which the 2425 mark presented a good support.

The European equity market is still positive year to date, showing a positive price return of 2.5% as at the end of August. The index is however still far from its yearly high posted in May (133.83), indicating a -5.7% decline till the end of August (126.19) and a -7.0% drawdown to its low posted in August (124.40).

The European market is currently trying to rebound to return to its YTD performance average (around 128). The May – August performance average lies around 129 and constitutes the most important resistance point for September.

The strong depreciation of the Dollar against the Euro hit the European equity market hard, as the investment community started to price in equity valuations and a new Forex regime. The Euro rose 13.25% from its closing price at the end of 2016, approaching 1.20 EUR/USD and continuing its up-trend, which started around the second round of the French elections.

The Investment Adviser measures the risk premium attached to equity markets in different ways. One way of measuring is to analyse the gap between the Index and its long term moving average. The statistical premium of the MSCI Europe Index shrank continuously from May onwards, when the Index price and its long term moving average deviated by around 10%. In August, the risk premium then turned negative. The MSCI Europe Index later however rebounded, closing near its moving average at the end of the month.

In August, the Fund lost -0.52%. Its performance was influenced by the difficult and volatile environment for European equities. The volatility within the portfolio is still under control even in times of a strong Dollar depreciation. In such an environment it is however difficult for the equity positions within the portfolio to capture alpha from good investment themes.

The Fund’s sector rotation is still quite strong, with those with a quality style bias performing better than the market and growth strategies outperforming value strategies, since the 10y Bund yield and yield curve have entered a new corrective phase. Throughout the month, the large cap sector was weak, impacting one of the funds in the portfolio. The team however thinks that this depicts a transitory headwind and that the underlying Fund can recover both in absolute and relative terms in the medium term.

From a statistical point of view, both August and September are bad months for equity markets. This said, the Investment Adviser thinks that the large loss posted by the European market in the summer time due to the Dollar depreciation could make the equity valuations appealing from a tactical point of view. This in turn may trigger the team to increase their net long exposure in the first part of September in order to try to catch some relative value.

If the Euro holds its 1.20 level and temporarily quits its uptrend, one may see some relative value emerge in Europe, which could constitute a tailwind for the Investment Adviser’s strategy.

The views and statements contained herein are those of Sofia SGR in their capacity as Investment Adviser to the Fund as of 15/09/2017 and are based on internal research and modelling.