View from an optimist

Guy Lerminiaux,
CIO Fundamental Equity DPAM


Key take-aways

  • The market always comes back as mean reversing is a strong pattern
  • No recession next year after this years’ soft patch in the second half
  • We have not seen the end of the cycle in Europe
  • Focus on stock picking in the non-regulated businesses
  • It is too early to give up

The big unwinding

2018 has been a quite distressing year, not only for Equities as nearly nothing has worked in 2018 for investors. Almost 90% of asset classes posted negative returns. This performance probably has a lot to do with the monetary regime change from quantitative easing to tightening and with the move towards more protectionism.

Guy Lerminiaux, as an optimist explains: “As the year progressed we saw some issues that we did not anticipated”. He highlights what he calls “the pitfall for the optimistic”. The optimistic knows he has to live with that without however getting carried away.

2018 is gradually coming to an end amid slowing global growth, tightening monetary policy and heightened political uncertainty. This environment is creating attractive entry points and investment opportunities.

Volatility would go up

As the year progressed, more and more investors were progressively de-risking their portfolios. Volatility is usually one of the measures to identify future recessions, however even if economic growth is set to moderate over the next two years, is too early for a recession

Going forward, we expect markets to remain volatile, as the trade war, the economic slowdown, Italian budget discussions with the EU, Brexit, etc. remain ongoing themes. But we are stock pickers, we like volatility, because it creates opportunities.

Risk aversion remains high. Economic leading indicators remain mixed and many political pitfalls are still present. At current valuations, these uncertainties are priced in. A better-than-expected outcome for any of the risk factors would therefore likely fuel a rebound in equities. Moreover, some inflationary pressures are starting to diminish. This will help corporate earnings, while also easing the pressure on central banks to increase interest rates. In the short term, we expect investors will sell into rebounds, as they are in the process of adjusting allocations between equities and bonds.

Meanwhile, the yield gap, the difference between the yields of government-issued securities and shares, is strongly supporting equities, as it was the case during the past few years as well.

Guy reminds us that we have seen similar examples of the situation today in the past. He mentions the crash of October 1987 brought fears of another Great Depression, but instead stocks recovered. Other example is the emerging financial crisis in 1998 when we saw a sharp drop of the market. The yield curve was saying that we were going into recession. The situation however improved and we had a nice resumption of the bull market afterwards.

VS US: A lost decade for large caps – small caps is another story

In the current context, large caps are in a complicated regulatory environment in Europe. Sectors such as banks, utilities, telecoms or the car industry in Germany are dealing with regulatory pressures that make these companies less attractive to invest.

On the contrary, European small caps remain in a better position. These stocks, less covered by the sell side community and the passive funds, are below the radar of investors and regulators, what allows them to perform in a less complex environment. Over a longer period, European small caps do NOT underperform their counterparts in US.

Following this, Guy highlights the case of the Belgian stock Colruyt as an illustration that “strange things happen from time to time”. He states “ Colruyt is a completely unloved company”. Strangely enough it is the best performing stock in the Belgian equity index and no one is buying it. This is a good example of “dislocation” in the equity markets due to massive outflows. For stock pickers it creates however opportunities.

Value or no value?

The market is discussing on whether we should invest in value or growth. In current this markets, we can still find opportunities in both pockets.


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