- The wall of worry for reflation and value appears rebuilt.
- Whilst absolute returns for indices have been contained recently, relative returns have not.
- The magnitude of relative sector dispersion in Europe over the last 6 weeks has been identical to the 6 weeks prior to the March 2020 pandemic low.
- This has reset expectations and valuations in our favoured companies to attractive levels, likely setting the scene for a stronger second half for value equities in Europe.
Whilst bond yields have declined, inflation expectations have moved less. In Europe inflation expectations have barely budged. Below we show the Five Year, Five Year Euro Inflation Swap. This is an indicator commonly used by central banks to assess the market’s future inflation expectations. There is no deflationary growth scare to be seen in Europe as of now.
This means that European real yields are now deeply negative, close to -2%, and in line with the record lows seen in recent years.
This decline in real yields has given extra oxygen to highly valued securities. But for expensive securities to keep outperforming, yields – both nominal and real – need to keep declining. For yields to go lower, bond market investors need to accept larger real losses than 2% per year. Whilst this is not impossible with quantitative easing dominating volumes, bond market investors will be required to envisage a truly pessimistic scenario for nominal GDP to justify these valuations. Our judgement remains there is an asymmetry in the long term risk profile here, with stable or higher yields more likely than lower yields. This outlook ought to support our positioning.
There is also a self-limiting element to the yield decline. Lower yields have enabled an easing of financial conditions, and perhaps a delay in Fed tightening. This ought to reduce the probability of an economic slowdown, extend the runway of the current expansion and underwrite cyclical earnings growth.
There are also investor concerns about peak stimulus. But the scale of growth in private sector deposits over the last 18 months is so large, that the positive stimulus effect will be extended over a long period as these excess savings re-enter the economy. Below we show European Private Sector Deposits in Euro trillions since 2000. Typically, private sector deposits grow in the Eurozone by €200-€400bn per year – but over the last year deposits jumped €1.1tn. This 12% year-over-year growth takes EU Private Sector Deposits close to €12tn, or over $14tn.
In the US the picture is even more extreme. US bank deposits typically rise by $500bn per year. But over the last year deposits rose by six times the normal rate, by a staggering $3tn, taking total system deposits to $17tn.
The scale of these excess savings both in Europe and in the US will help underwrite this recovery. Inventories across supply chains remain low, lead times remain long. The outlook for cyclical earnings growth remains solid. The recent dip in bond yields will act to stimulate the recovery further. The dispersion in returns in recent weeks likely provides an attractive entry point for European value equities and an attractive exit point for expensive securities. We remain optimistic about the absolute and relative returns for the LF Lightman European Fund in 2021.
Lightman – July 2021
Past performance is not an indicator of future performance. The value of investment might fall as well as rise.
Dividend yields are gross of costs and taxes and assumes all dividends will be paid in cash. Actual yields will be net of costs and any applicable withholding taxes and the Lightman may choose stocks over cash as dividends or an isser may only mandatorily pay dividends in form of stocks or another security. There may result in the yield being lower than the amount shown above.
This document is owned by Lightman Investment Management Limited (“Lightman”, “we”, “us”). Lightman Investment Management Limited (FRN: 827120) is authorised and regulated by the Financial Conduct Authority (“FCA”) as a UK MiFID portfolio manager eligible to deal with professional clients and eligible counterparties in the UK. Lightman is registered with Companies House in England and Wales under the registration number 11647387, having its registered office at c/o Buzzacott LLP, 130 Wood Street, London, United Kingdom, EC2V 6DL.
This document is intended for ‘Eligible Counterparties’ and ‘Professional’ clients only, as described under the UK Financial Services and Markets Act 2000 (“FSMA”) (and any amendments to it). This document is not intended for ‘Retail’ clients and Lightman does not have permission to provide investment services to retail clients. Any marketing document is only intended for ‘Eligible Counterparties’ and ‘Professional’ clients in the UK, unless it is being used for purposes other than marketing, such as regulations and compliance etc.
Collective Investment Scheme(s):
The collective investment scheme(s) – LF Lightman Investment Funds (PRN: 838695) (“UK OEIC”, “UK umbrella”), and LF Lightman European Fund (PRN: 838696) (“sub-fund”, “UK product”) referenced in this document are regulated collective scheme(s), authorised and regulated by the FCA. In accordance with Section 238 of FSMA, such schemes can be marketed to the UK general public. Lightman, however, does not intend to receive subscription or redemption orders from retail clients and accordingly such retail clients should either contact their investment adviser or the Management Company Link Fund Solutions (“Link”) in relation to any fund documents.
The collective investment scheme(s) – Elevation Fund SICAV (Code: O00012482) (“Lux SICAV”, “Lux umbrella”), and Lightman European Equities Fund (Code: O00012482_00000002) (“sub-fund”, “Lux product”) referenced in this document are regulated undertakings for collective investments in transferrable securities (UCITS), authorised and regulated by the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg. In accordance with regulatory approvals obtained under the requirements of the Law of 17 December 2010 relating to undertakings for collective investment, the schemes can be marketed to the public in Luxembourg and Norway. Lightman, however, does not intend to receive subscription or redemption orders from any client types for the Lux product and accordingly such client should either contact their investment advisor or the Management Company LINK FUND SOLUTIONS (LUXEMBOURG) S.A. (“Link Lux”) in relation to any fund documents.
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Wherever the document refers to a third party such as Link, Northern Trust etc., we cannot accept any responsibility for the availability of their services or the accuracy and correctness of their content. We urge users to contact the third party for any query related to their services.
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This document is not intended for any person outside of the UK or the European Economic Area (EEA). Lightman or any of the funds referenced on this document are not approved for marketing outside of the UK or the EEA. All non-UK and non-EEA persons must consult their domestic lawyers in relation to services or products offered by Lightman.
Risk warning to all investors:
The value of investments in any financial assets may fall as well as rise. Investors may not get back the amount they originally invested. Past performance is not an indicator of future performance. Potential investors should not use this document as the basis of an investment decision. Decisions to invest in any fund should be taken only on the basis of information available in the latest fund documents. Potential investors should carefully consider the risks described in those documents and, if required, consult a financial adviser before deciding to invest.
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