Who would have expected that European equities would be one of the best performing asset categories globally in 2012 with a return in euros of 18.6%?
Perfect foresight on political and economic developments at the start of the year would have served only to hinder your abilities to get that forecast right. The European equity index has had more twists and turns than a good thriller over the past few years and 2012 was no exception.
The major variable over the year was confidence, as growth expectations – even for the previously impervious German economy – hit a low at the end of the period. Investors started the year dwelling excessively on the negatives and ended the year focusing on the positives even though, from a big picture perspective, little had changed.
To take an old well-worn phrase, the market has gone from perceiving the European equity space as half empty to half full in the last few weeks of the year.
Confidence is a fickle friend and has ebbed back and forth since the credit crisis erupted. Markets have now entered a period when Keynes’ ‘animal spirits’ have become hungry for risk again.
In terms of outlook for 2013 we feel confident there will be no economic depression – as implied by the yield on AAA bonds – but neither will there be a robust economic recovery – as implied by the valuation of many industrial and cyclical businesses whose earnings estimates are still falling.
The unfolding reporting season will be the litmus test of the depth of confidence the market participants have in the rally in equities, and especially in the more cyclical and higher risk areas.
The extent of the rally has raised profit expectations implicit in many stock prices, and as the valuation of a stock gets driven by its profitability in the long run, there has to be evidence of a better tomorrow to maintain the upward momentum seen in the cyclical names. There is only so far you can get on a re-rating story alone. It is more about stock selection than a bet on market direction.
Andrew Parry, CEO of Hermes Sourcecap, managers of the Hermes Sourcecap European Alpha fund
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