Europe stock-pickers to profit as macro focus wanes

Tue Dec 11, 2012 10:51am EST

* Euro STOXX stock price correlations falling

* Global macro hedge funds underperform in 2012

* Fundamentally sound stocks set to perform well

By Tricia Wright

LONDON, Dec 11 (Reuters) - European stock investors who bet on a company's core strengths should outperform those guided by macroeconomic and political factors in 2013 as the big picture themes that dominated during the financial crisis recede.

In times when macroeconomic, or "top-down", issues are at the fore of investors' minds, such as between 2007 and 2011, equities for the most part move up or down with relatively little differentiation between companies.

That period may be drawing to a close, though, with measures by the European Central Bank to defuse the debt crisis assuaging worries the euro zone could fracture and the latest data suggesting fears China's economy was slowing too fast were unfounded.

"The market's becoming much more micro, much less macro," Hasan Tevfik, strategist at Citi, said.

Polls indicate investors are less concerned about the potential impact of macroeconomic factors.

This change should mean fundamentally sound stocks which suffered in indiscriminate sell-offs, or stocks which rose unjustifiably in broad rallies, will start to perform on the basis of merit.

Firms in sectors from financials to retailers have started to show signs of divergence from the broader market trend.

"We've been in an environment where most market commentators have spoken as if we're in a risk-on/risk-off mode, and it's either all the risky assets going up, or they're all going down," Andrew Cole of Baring Asset Management, said.

"That environment is coming to an end, or seems to be less prevalent," added the fund manager, whose firm has around 31 billion pounds ($49.9 billion) of assets under management.

The Euro STOXX average stock correlation, which measures the degree to which shares move in unison, is approaching a post-crisis low, having fallen from an end-2011 peak of 0.8 to 0.52, on a scale where zero means stocks move totally independently and 1.0 shows they are perfectly in sync.

Periods characterised by extreme swings in market sentiment are frustrating for so-called "bottom-up" fund managers, who pick stocks based on their underlying fundamentals, such as return on assets and cash flow.

Equity funds using the long/short hedge fund strategy, in which managers focus on bottom-up factors lost 5.96 percent in 2011 when markets were highly correlated, underperforming global macro funds, which were down 1.73 percent, data from the EDHEC Risk Institute showed.

That trend seems to have already turned. Global macro hedge funds have returned just 2.1 percent this year, against a 5.5 percent return from the long/short strategy.

As top-down influences subside, the underlying fundamentals assume greater relevance, giving fund managers the chance to put their research to work to differentiate between stocks.

"It's a far more intelligent environment. It's not just one bet on or off... It means we can really generate more performance," Lucy MacDonald, CIO Global Equities at Allianz Global Investors, which manages around 300 billion euros.

In 2011, Allianz GI lifted its exposure to Germany's Munich Re, the world's biggest reinsurer, perceiving the firm to have been unfairly punished by a sell-off in the third quarter fuelled by fears of a euro zone break-up.

Munich Re has in fact started to show signs of bucking the trend seen in the wider market, spiking higher at the start of November when Europe's STOXX 50 suffered a sell-off.

However, bouts of concern, for example over the $600 billion U.S. "fiscal cliff" of tax hikes and spending cuts, and a Greek exit from the euro zone, could yet see the big picture factors drive equity markets again.

But overall, the macro picture looks less uncertain, with global investors raising their equity overweight positions to a 20-month high in November on fading worries about fiscal issues on both sides of the Atlantic, according to a Reuters poll

Citi has devised a basket of "Good Stocks in Bad Markets", comprising firms which enjoy robust growth and that the bank perceives to be fundamentally sound but to have been unjustly penalised in a risk-off environment.

These include French spirits group Pernod Ricard, Italian tractor and truck maker Fiat Industrial, and Spain's Inditex, the world's biggest clothing retailer and owner of the Zara brand.

Reflecting weaker stock price correlations, the share price performances of all three have at times in the past weeks been at odds with the wider market trend.

"Maybe we'll go into a period where macro is going to take over for a little bit, but what's been the case for all of this year is that these periods are becoming less often," Citi's Tevfik said.

FILED UNDER: