Tailwind for European stock-pickers
Markets finally took a breather after weeks of appreciation. European stocks underperformed, caught in between a sharp repricing in govies yield and a rising Euro. Japanese and EM stocks were more resilient. Sector rotations sanctioned energy stocks in sync with the pull back in crude prices and a recovering dollar. Healthcare stocks corrected after the State of the Union speech and the Amazon, Berkshire and JP Morgan drug platform initiative.
Hedge funds gave back some of the recent gains. CTAs and Global Macro underperformed, dragged by their long in equities and energy. Conversely, Event Driven funds and L/S Neutral funds proved resilient. Hard-catalyst stocks were reasonably spared while equity rotations proved rather sector than factor driven.
This week we review the environment for European stock-pickers. Opportunities seem substantial given the wide set of stocks with upside from their operational leverage and firming corporate activity. Multiple themes are available, including, the French reforms, the Greek & Italian banks consolidation, a capex revival etc.
Like in other regions, correlations collapsed, suggesting unrelated stock movers. As a result, portfolios bear less correlation risk. Moreover, ample liquidity and economic conditions allow investors to focus on companies. Stock discrimination actually intensified, evidenced by returns after earning releases, increasingly driven by company specifics. Stock dispersion remains moderate but is higher than what implies the low volatility level.
The potential for alpha generation seems strong, but has yet to unleash when political risk have eased. The economic recovery, the reforms led in France, a more Europhile German government all increase the odds for reforms in Eurozone. Their nature has yet to be determined with two main opposing lines represented by the Northern and the Southern members. The current political dynamic suggests more spending and more fiscal integration could have better odds than the reforms toward greater financial risk-sharing. The key risk lies with the Italian elections. Prospects of an Italexit seem remote but an adverse electoral result could break the dynamic in Eurozone reforms. It could discourage foreign investors and question the recovery sustainability. Save a major Italian surprise, prospects for European stock pickers have improved in our view.
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