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European Equities, what’s up?

We are at that time of the year when markets enter a deliberate peaceful phase. June, July and especially August are typically the months when the passing of the cold weather, thoughts of sandy beaches and sniffs of BBQ sausages reduce the urgency for action or aggressiveness; 'sell in May and go away' they call it.

But will summer 2018 follow the typical trend?

When asked whether the current market environment worries him, Goldman Sachs CEO Lloyd Blankfein responded that 98 per cent of the time he is worried about the 2 per cent worst outcomes. Currently he is worried about the impact of rising interest rates on portfolios, the impact of Brexit on the EU, the impact of debt on Italy and Greece and on the impact of geopolitical event in general. Worry seems to be the main driver of performance for Blankfein.

What should we be worried about? If one were to look at the long-term picture, figures are impressive. European equities are now into their 10th year of what can be termed a consistent rally. Counting from the depth of the Lehman crisis European Equities are now 92 per cent up. This figure includes a 35 per cent correction during the 2011 Greek crisis and a 30 per cent correction in 2015/2016 that followed a sell-off in Asian assets.

Looking back, these corrections proved to be opportunities that paved the way to further upside. Still, unless you are one to believe that the economic cycle is dead, a recession sometime in the future is unavoidable. The million dollar question is timing.

There is also the argument of magnitude. In the 1970s, Australian and Californian fireman used to fight hard to try to eliminate all forest and bush fires. This resulted in long periods of calm followed by the occasional catastrophic fires. Nowadays, fireman leave most of the small fires to die naturally; the difference is that the occasional big ones have become much less damaging.

Arguably financial markets have entered a similar phase and bearish analysts contend that the next crisis will dwarf the previous recession. However, while I fully appreciate bearish concerns and support the view that a recession may be on the cards, I prefer holding on to a balanced view that is filled with shades of grey rather than simple black and white. Let me explain:

Small fires
While aggressive central bank intervention has assisted in creating one of the longest rallies recorded, the period between 2008 and today cannot be described as a straight line. The Greek and Asian examples mentioned above, Brexit and even this year’s sell-off easily represent the small fires that seem to be overlooked by some bearish corners. This does not mean that a tipping point is far away, however, European financial institutions are much better prepared this time round, large corporates are cash rich and small firms have been able to refinance cheaply. This time round there is confidence that Europe is much better prepared.

Interest rates
Whether interest rates are a headwind or tailwind is debatable, or rather, the argument of causality should always be included when modelling the impact of interest rates on economies and financial markets.

Rising interest rates are intended to calm a possibly overheating economy. However, the possibility of an overheating economy must be present to contemplate increasing rates in the first place. This explains the historical positive correlation between interest rates and equity markets. Thus, based on historical evidence, equity investors have no reason to fear rising rates.

Business cycle
The eurozone is entering its 5th year of economic growth and there are few signs that would indicated a reversal of the trend going forward. Employment continues to improve and risks are political rather than economic, which brings us the big outlier…

Geopolitics
Finally the outliers: Trump, Russia, populism, Brexit are all outliers that have significant short-term if not long-term impact on financial markets. However, it is my opinion that attempts to anticipate outcomes and invest based on these events is closer to gambling than I would be comfortable with.

My recommendation remains consistent. Put your money into well-managed growing companies. Trust the management of the company to make the required decision to grow the company and thus your investment. What happens over a few days or weeks due to some alpha dog wrangling is just background noise.

Disclaimer:
This article was issued by Antoine Briffa, investment manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

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