Investment climate in Europe still healthy despite market slide in June


Monthly Fund Commentary
27 Jul 2017


In June, the European stock market experienced a constant and gradual slide. In the first half of May the MSCI Europe Index posted a high of 133.8, following the French elections. This movement was followed by two corrections: After having reached the month’s top on 2nd June, the first decrease happened over the first half of June, whilst the second downside swing occurred on 20th June and continued until month end, with a bear climax on the first two days of July.

Overall, the MSCI Europe Index was down -2,69% (price change) in June and underperformed the American stock market in Euro terms, with the magnitude of the correction in the United States being more restrained.

Despite short term performance, the stock market is still positive year to date. The MSCI Europe Index gave back half of the gains, which it accrued from its low at the end of January to its top reached in May. However, the investment climate in Europe can still be defined as healthy, since the streak of relative highs and lows posted by the market is still active and ascending. With a correction of 3-5%, the market trend is still positive, accordingly investors have to wait for more cracks in the wall to determine whether the bull market is over. Without further negative developments, the Investment Adviser views the June correction as an average countermove in an upward trending market.

The main driver behind these developments was the language adopted by the Central Banks, both in their official meetings as well as in several speeches and international gatherings. In line with the Investment Adviser’s expectations, the FED was hawkish both, in actions and in words, with their exit strategy from the quantitative easing being just around the corner. The ECB, which is far from ending stimulative policies, still gave the market a few hints that something is changing inside the Council, with a will for normalisation emerging.

Following the behaviour of the Central Banks, a strong sector rotation took place. Investors particularly sold positions from sectors which are typically associated with a deflationary environment. The only two areas of the market that did well were Financials (who would benefit from a higher interest rate environment in the near future) and basic resources sectors. Positions in the Oil & Gas, Technology and the “bond-like” sectors (Utilities and Telecommunications) were sold strongly. Banks constituted the only positive exception during the market slide.

In June, the risk premium in the European equity market rose. On 30th June the gap between the stock market and its 200-day moving average was half when compared to that of the 31st May. Still, there is some premium in equity valuations, but the Investment Adviser thinks that it is more manageable than in May.

The volatility of the Eurostoxx 50 equity market was quite unstable. In the first part of the month the V2X Index moved between 13 and 15, followed by a rise to the month’s peak of 18 on 29th June. The V2X posted an especially sharp rise in the last two trading sessions of the month. The sell-off in bonds and the more bond-related equity sectors led to a climax in volatility. However, even in the more pronounced moment of stress, the V2X Index did not reach the threshold of 20 in June.

The typical seasonality of June was a good indicator for the month, with the main stance being cautious. With July approaching, the Investment Adviser would like to highlight the fact that it is a very good month from a statistical point of view. Hence, it could be interesting to identify market levels at which an attractive risk/reward ratio and an appropriate risk premium are offered, leading the team to abandon the cautious stance and increase the portfolio’s net long exposure.

The Investment Adviser does not see any signs of excessive pessimism. “Smart money” still has a positive approach and this could be supportive for equity markets, preventing huge corrections and limiting the downside risk to 3-5%, as observed in June.

In June the Strategic Beta Flex performance was down, with the sector rotation being the main driver. Positions in the Financials sector limited the portfolio’s loss. The prevailing part of the long portfolio is made up of quality themes, which express their value in the long run, but can experience short term drawdowns in absolute and relative terms. This especially occurs when the market profits from investments, which posted excellent returns in the last few months and reallocates to value and low-quality themes.

In the first part of the month the Fund held a low net long equity exposure, after which the Investment Adviser tried to take advantage of the market correction by raising net long exposure. This was however a little disappointing, since the downside move continued until the end of the month.

Again, in July the team’s focus will lie on Central Banks. Thus far there are no major interventions in sight, but the Investment Adviser thinks that both, Mario Draghi and Janet Yellen could send clearer messages about their long term view and approach. July could offer good opportunities for equity investors: Following the harsh month of June, the Investment Adviser believes that a recovery may be on its way. The team will therefore focus on the central part of the year (roughly May – October) as a consolidation phase. The Investment Adviser thinks that there is value to be caught in the later part of the year, as the macroeconomic context is still favourable. For now however, a cautious approach is key, as markets may need a consolidation phase given the strong bull move during the first four months.

The views and statements contained herein are those of Sofia SGR in their capacity as Investment Adviser to the Fund as of 19/07/2017 and are based on internal research and modelling.