French presidential election result good for the stability of the Euro area

BY PAOLO MARONGIU

Monthly Fund Commentary
23 May 2017

BY PAOLO MARONGIU

The second half of April was a good period for European equities, with the MSCI Europe Index (MXEU) rising to close up 1.3% on a monthly basis. In the early part of April the index had traded sideways, but after a large drawdown on 18th April, rebounded strongly on 24th April.

April was also a very good month for European equities in relative terms, especially in Euro terms, where the currency impact meant the S&P500 was flat. The global market gains of 24th April were largely erased by currency moves. Again, the main contribution to the good performance of the European market came from Eurozone markets, as the French market generated good returns. The outcome of the first presidential electoral round in France was good for the stability of the Euro area, reducing the risk of a Le Pen victory and ultimately of a referendum on the Euro currency and, in the end, of a Euro area breakup.

The risk premium attached to the European equity market dropped and equity valuations spiked, especially in the financial sector. Volatility attached to the Eurostoxx 50 equity market dropped from 25 to 15 in two days and then stabilised, with a slight pickup in the last days of the month, as the second and final French electoral round was approaching.

Bond markets were flat both in the United States and Germany, Bund futures had spiked to 164 before the first round of the French elections but later dropped to 160.6. The political risk premium attached to the German Bund declined and this allowed the 10 year yield to reach 0.39% in the last days of the month, having reached a low of 0.15% mid-April, when the polls still projected an uncertain outcome for the French elections.

Seasonality is still very favourable for equities in post US election years. The excellent uptrend of the American stock market from November to January projected six months of good returns for equities. In more than one hundred years of American stock market history, the time span between May and mid-October is typically not as favourable, so the contribution from seasonality is now mixed.

Market sentiment is also mixed. There is not yet an excess of complacency among the global investment community, but neither is there too much pessimism. “Smart money” and “retail” sentiment are quite balanced. The S&P500 is approaching the March high of 2400.98 and is trying to cross it, but we need more participation from certain sectors and single stocks: few stocks are making new highs while the market is on the verge of a new one.

In April the Strategic Beta Flex Fund rose, the first half of the month saw a slight move upwards, then an almost imperceptible correction took place while volatility picked up (the maximum monthly drawdown of the fund was -0.35%) and then a strong up move took place in the last part of the month. The Fund held a stable mid–high net long equity exposure and the goal remains to achieve stable returns with controlled volatility.

The risk premium attached to global equities is still quite favourable but in Europe it has shrunk a lot in the first part of the year. When markets achieve large gains in a very short time frame it’s always preferable to avoid the maximum net long exposure and adopt a more balanced stance. There is still relative value ready to be captured in the later part of the year, as the macroeconomic context is still favourable, so the Investment Adviser may not cover the entire long exposure. However, the team may adopt a very cautious stance if political risk emerges, both in France and in North Korea.

The US yield curve flattened significantly in April, we don’t know yet if this move is going to be reversed in the short term, as investors are awaiting evidence that reflation is still on the agenda of the new Administration, which is debatable at the moment. If the reflation rhetoric ignites once again, the investment team will adjust the portfolio style, switching from growth and quality themes to a value approach. Otherwise, the long side of the portfolio will continue to be balanced and diversified.

 

The views and statements contained herein are those of Sofia SGR in their capacity as Investment Adviser to the Fund as of 22/05/2017 and are based on internal research and modelling.