BY PAOLO MARONGIU
In July, the European stock market moved sideways, with weak and short-lived rebounds and a continuation of the slide, which had previously characterized June. In the first half of July, the MSCI Europe Index posted a high of 131.56, followed by a correction which made the market return to its previous lows (near 127.50).
The last part of the month saw a non-directional movement. The European equity market moved in a tight trading range, trying to rebound from time to time, but never showing real signs of strength, ending the month down 0.42% (price change). Throughout July, the MSCI Europe Index moved between 130.59 (high) and 127.54 (low), which was also July’s closing value.
The European equity market is still positive year to date. The MSCI Europe Index is hovering midway between the year high and low. The investment climate in Europe can still be defined as healthy, with the market still being active and ascending. According to the Investment Adviser, the macro and micro data seems to support the development of equity markets. The correction is so far still contained between a 3-5% range, leaving the market trend unchanged.
As previously stated in the June commentary, the equity market correction depicts an average countermove in an upward trending market, as long as the market continues to post higher relative highs and lows. The main focus now lies on the YTD average (128.04) and on the relative low posted in April (127.12). These are the two levels the market needs to hold in order to confirm the positive structural bias.
Global markets outperformed European markets in July. The movements of the American stock market confirmed the good seasonality associated with the month of July. The main driver for the European market’s underperformance was the depreciation of the Dollar, which lost ground against the Euro. The appreciation of the Euro (from 1.14 to 1.18 USD/Euro) particularly impacted European markets, which are typically more focused on the export of goods.
Facing a difficult environment, the Fund was down 0.23% in July. Volatility within the portfolio remained under control, despite the large impact of the Dollar depreciation.
In July, the Central Banks adopted a slightly less hawkish stance. However, the exit strategy from the quantitative easing programme remains the focus, both in the United States and even more so in Europe, where the inflation target is still far from being met, since the reflationary effect through last year’s Oil price developments is fading and the structural deflationary environment is emerging once again.
The strong sector rotation which took place between the end of June and the beginning of July was muted over the last few weeks. The sectors which are typically associated with a deflationary environment could recover slightly, since the main focus of the sellers was on the more Euro-related themes. Banks performed well, despite steady or declining risk-free 10y yields. BNP, Intesa and Unicredit had a strong and above consensus expectations reporting season, whereas Societe Generale and Deutsche Bank were below expectations.
In July, the risk premium, defined as the gap between the stock market and its 200-day moving average, decreased to less than 2% at month end, with the stock market approaching a more adequate risk premium area. The volatility of the Eurostoxx 50 equity market (V2X) declined partially in response to the new lows posted by the Vix in the USA. Even the rebound of the V2X in the second part of the month was short-lived and challenged the medium term lows.
The typical seasonality of July was perceived positively. The MSCI Europe’s risk premium was lower than in June, giving the Investment Adviser the opportunity to partially unhedge the long side of the portfolio. However, the underperformance of the European equity markets penalized the team’s strategy. As August, a month that is typically associated with negative seasonality is approaching, the huge divergence between Europe and the USA, which is based on FX movements, may lead the Investment Adviser to take a less cautious stance on the European markets.
In the USA, the Investment Adviser can now see signs of excessive optimism and new dangerous divergences. According to the team, a diverging pattern emerges between the S&P500 and the S&P Equal Weight Index, which usually leads to poor returns in the short to medium term for the American equity market. As the Investment Adviser mentioned before, the European and American markets may converge slightly over the next two months, in order to close the gap which opened in July due to the FX movements. If the Euro holds its 1.20 level against the USD and temporarily quits its uptrend, one may see some relative value emerging in Europe.
The views and statements contained herein are those of Sofia SGR in their capacity as Investment Adviser to the Fund as of 17/08/2017 and are based on internal research and modelling.