Spring is finally here, and it looks like the weather is gradually improving. We got so used to the gloom of March and April that it’s perhaps natural to extrapolate the same conditions for May. But the sunshine came unexpectedly. Put differently, in investment jargon, relative to our downbeat expectations, we got a surprise to the upside.
Something similar is beginning to happen to the Eurozone (and the UK). It showed signs of recovery in the first quarter of this year, as the economy came out of the mild recession it experienced in the second half of last year. It grew above expectations and at the fastest rate since the third quarter of 2022. As inflation continues to soften, we expect the European Central Bank (ECB) to start cutting interest rates in June, before the US Federal Reserve (Fed).
As the outlook for Europe is getting better, a trend we believe is underappreciated in the marketplace, I and the Investment Committee have decided to shift the mix of assets we hold in the region. When the outlook improves, the course of action is to raise equity exposure and reduce bond exposure, which is what we’ve done this month.
-Daniele-Antonucci-Chief-Investment-Officer-Quintet.jpg?width=650&height=650&ext=.jpg)
Over the past three months, we’ve owned more European investment grade bonds relative to our long-term asset allocation. We still believe they are high-quality corporate bonds, but the price of these bonds has increased (and the yield, which has an inverse relationship with the price, has decreased). This increase in price reflects market expectations of better economic growth and ECB interest rate reductions at around mid-year.
The key valuation measure for corporate bonds is the ‘spread’. In simple terms, this is the difference in yield between corporate and risk-free bonds. When the spread tightens, it means that corporate bonds are performing well. When it tightens below the long-term average, it’s a signal that valuations are perhaps becoming relatively more expensive. That’s where we are now, so we’ve reduced our exposure.
The European economy seems to have picked up momentum. And it’s not just the headline figures on Gross Domestic Product (GDP). If it were only that, one would want to take any improvement with a pinch of salt. This is because concepts such as GDP, while useful, are like looking at the economy via the rearview mirror. More timely and forward-looking indicators, such as the Purchasing Managers’ Indices (PMIs) and consumer confidence, show that the Eurozone economy is on a recovery path. Add to that the prospect of interest rate cuts from June now that inflation has slowed to 2.4% (very close to the ECB 2% target), and we believe this recovery might well continue.
Think of our switch from European bonds to equities as a continuation of what we did last month, when we shifted our minimum-volatility European equities into the broader European market. The logic was that, in Europe, growth was still weak but no longer getting worse. Rather, it appeared to have bottomed out. Therefore, we thought it was unlikely that European minimum-volatility sectors (which do comparatively well when the economy is worsening) would outperform the broader European market. This is the same concept. We think it’s unlikely that European equities (excluding UK) will underperform global equities, and so we’re adding to this market, where valuations are attractive.
You may already be aware that our parent company Quintet recently launched the first two in a series of multi-manager funds, known as our QMM fund range, which was co-created with BlackRock. In April, Quintet launched the QMM Actively Managed US Equity Fund and the QMM Actively Managed Global High Yield Bond Fund.
QMM, which blends leading third-party managers with the aim of outperforming the benchmark by combining different styles of actively managed strategies, is available to all Quintet group clients, from those who invest in our flagship portfolios to those in customised and advisory portfolios.
Last week saw the launch of the third QMM fund: the Actively Managed Continental European Equity Fund. This month’s investment into European equities ex UK has been implemented through this new fund.
In our previous Counterpoint, I spoke about how we’d brought our equity and bond allocations “back to neutral” at the start of 2024. As a reminder, this simply means that our short-term allocation aligns with our long-term allocation – at least for equities and bonds. Our sale of European investment grade bonds and purchase of European equities ex UK means that, technically, we now own very slightly more equities compared to our long-term allocation. But it’s important to put this in context.
While the outlook for Europe (and more broadly) appears to be improving, one doesn’t want to be complacent. We’re not making this trade because we believe European equities are going to take off. In fact, we still have a slightly reduced exposure to European equities, just less than before. Similarly, we still own more European investment grade bonds relative to our long-term allocation. Again, just less than before. And we still think this asset class is compelling from a medium-term perspective, so continuing to earn a good rate of interest seems like the right thing to do.
Our aim is to protect and grow our clients’ wealth. So, we think it’s good practice to move step by step and validate our assumptions on markets, the economy and companies. We want to see whether the European recovery we envisage, and begin to see in the data, really takes hold more firmly.
Important Information
Information correct as of 10 May 2024.
This document is designed as marketing material. This document has been composed by Brown Shipley & Co Ltd ("Brown Shipley”). Brown Shipley is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered in England and Wales No. 398426. Registered Office: 2 Moorgate, London, EC2R 6AG.
This document is for information purposes only, does not constitute individual (investment or tax) advice and investment decisions must not be based merely on this document. Whenever this document mentions a product, service or advice, it should be considered only as an indication or summary and cannot be seen as complete or fully accurate. All (investment or tax) decisions based on this information are for your own expense and for your own risk. You should (have) assess(ed) whether the product or service is suitable for your situation. Brown Shipley and its employees cannot be held liable for any loss or damage arising out of the use of (any part of) this document.
The contents of this document are based on publicly available information and/or sources which we deem trustworthy. Although reasonable care has been employed to publish data and information as truthfully and correctly as possible, we cannot accept any liability for the contents of this document, as far as it is based on those sources.
Investing involves risks and the value of investments may go up or down. Past performance is no indication of future performance. Currency fluctuations may influence your returns.
The information included is subject to change and Brown Shipley has no obligation after the date of publication of the text to update or amend the information accordingly. Accordingly, this material may have already been updated, modified, amended and/or supplemented by the time you receive or access it.
This is non-independent research and it has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead of the dissemination of investment research.
All copyrights and trademarks regarding this document are held by Brown Shipley, unless expressly stated otherwise. You are not allowed to copy, duplicate in any form or redistribute or use in any way the contents of this document, completely or partially, without the prior explicit and written approval of Brown Shipley. Notwithstanding anything herein to the contrary, and except as required to enable compliance with applicable securities law. See the privacy notice on our website for how your personal data is used (https://brownshipley.com/en-gb/privacy-and-cookie-policy).
© Brown Shipley 2024
.png?width=650&resizemode=force)