Michele Ragazzi
Partner | Portfolio Manager
Current Outlook
The European banks' stress test and Basel III announcements in the last week of July have had a very positive impact not only on the banking sector performance but also on sovereign stress; the spread between German and Spanish 10Y Treasuries has gone down by 50 basis points to 150 basis points in the space of 10 days. Also, the stress in funding markets is moderating. European activity has shown very good resiliency, which I expected, however, in my view, the outperformance on the US economy is not going to last with the European activity indicators slowing.
As I am writing (11-Aug), the FED has just announced its first step toward 'Quantitative Easing II' effectively confirming that the US economy is substantially weakening.
I keep on finding the performance of US treasuries very disquieting for anybody that wants to be long of the stock markets; the 10Y yield has moved down by about 1% to 2.75% since the end of April when the stock market was at this level. Part of this move is due to easing of inflation expectations and part to growth expectations coming down; in any case the substantial reduction of expected nominal growth implied by the Treasury market cannot be positive for stocks, in my opinion.
The only real bullish argument that I can find is that European stocks look cheap on 10.7x 2011 P/E and 3.5% dividend yield. However, I feel that the story that the Treasury market is telling is that the elevated earnings expectations for next year are going to come down.
In conclusion, as equities - after 10 years of bear market - are becoming more and more of a hated asset class I feel more interested in their long term qualities but not at a time when the Treasury market is holding such a different and negative view of the future.
In practice, I believe that the market is more likely to go down than up or that at least will go into a rotation selling cyclical stocks and buying steady earnings/yield. As a consequence I have bought put options on the index, shorted industrial stocks and started shorting south European banks; even if still slightly net long this is a book that will behave as a net short book.
A couple of comments on stocks. Ocado has been listed; its listing has been very unsuccessful, though, which honestly I didn't expect. The IPO pricing has been cut from a minimum of 200p to 180p and is now trading at 155, making it the most unsuccessful IPO in the last 3 years (it was marked in our books at 135p). The positives are that they have raised £200m of fresh funds and that the stock is now sellable and in fact I have sold half of the position. Ericsson didn't report well (again) which prompted the stock to come off quite substantially together with the price of the option we hold. I still believe the stock is good value and the price of the option is much higher than the price we paid.
30th July 2010.
Chart of the 10Y US Treasury.
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