* Still in ‘Recession’ - but very, very close to 'Recovery'
Our European Composite Macro Indicator improved for the first time in a year. If
signals improve again next month, the confirmation will move the Style Cycle into
the ‘Recovery’ phase from ‘Recession’ (pg12). When this happens, Value, Risk and
Small Size stocks should consistently outperform.
* Four indicators improve; one flat and one falling
The four inputs that are most sensitive to European data are rising: Pan-European
GDP forecasts, changes in Pan-European bond yields, YoY changes in the OECD
European Leading Indicator and the German IFO Indicator. However, macro data
sensitive to global cycle have yet to show recovery. The Global EPS Revision Ratio
is flat on last month and Producer Price Inflation (representative of commodity
weakness) has yet to show recovery.
* Sentiment stretched, FX driving earnings & performance
“European Recovery” seems to be the most consensual trade, as affirmed by flows
into European stocks, stretched sentiment readings from our Fund Manager Survey
and even by listening to the pundits. However, most of the excitement is following a
weakening Euro, which benefits exporters both cyclical and defensive (cover chart).
The play of FX is so strong that over the past 12 months, US stocks are up 40% for
Euro investors, while European stocks are down 10% for US$ investors.
--> When we enter the ‘Recovery’ phase, macro fundamentals should drive market
performance beyond any FX effects. It will favour European Financials (domestic
exposed Value) over Staples (high Quality exporter). In contrast, the key to beating
the benchmark in past months has simply been to avoid Value styles in Financials
and commodity sectors.