Positioning for macro shifts: An interview with Olivier d’Assier

What does the risk-return picture look like in European markets this year? Anything unusual? Any red flags? 

Like many of their peers, European investors have been trying to guess when inflation will finally drop to the ECB’s targeted goal, whether the economy will have a soft or a hard landing because of the higher-for-longer interest rate environment, and when the ECB will pivot to a more accommodative monetary policy. What has been rather unusual during 2023 is that despite two theatres of war, an uncertain macro picture and the highest interest rates in 22 years, the volatility of some of the most popular European indexes, the STOXX^® Europe 600, the EURO STOXX 50^® and even the EURO STOXX^® Banks, has been declining all year. When we combine this picture with declining market volume (in terms of average daily traded volumes) and increasing concentration around just three sectors —consumer discretionary (luxury goods), financials, and industrials — we get a picture of fewer investors participating in the stock market. The bulk has already moved into the fixed-income market over the past 18 months. The investors left in equities are plagued by indecision, given the high levels of uncertainty in the macro and geopolitical sphere. Large European banks, as a proxy for the economy, have gained interest with investors and the EURO STOXX^® Bank index is up 20% since the short-lived banking crisis in March, even outperforming its blue-chip peer, the EURO STOXX 50^® and the broader STOXX^® Europe 600 index.

What have been the key drivers of risk in European markets this year, and how should investors position their portfolios to manage them? 

Inflation continues to be well above the ECB’s target of 2%, and the higher-for-longer interest rate environment led to many investors anticipating a hard landing for the economy, seeking refuge in the safety of the fixed-income market. Those investors who remained in equities have continued to favor the more risk-averse segments of the market and are buying large-cap stocks with a well-diversified revenue base, profitable income statements, and little or no debt. Unlike during the European debt crisis, investors now see banks as the safest segment of the market, offering refuge from high levels of uncertainty. They have been looking for safety first, then quality, then breadth. This is evident by the outperformance of the EURO STOXX^® Banks index over its blue-chip counterpart, the EURO STOXX 50^®, and the broader STOXX^® Europe 600 index. But, as inflation data improves, and with the ECB  staying its hand for the third consecutive meeting, investor sentiment is improving. There are signs that some flows are returning to the stock market, in anticipation of a pivot by the ECB in the first half of 2024. This could mean that investors may now prefer the broader index over its narrower peers, especially as the latter becomes relatively expensive due to its popularity in 2023.

What have been the key drivers of risk in European markets this year, and how should investors position their portfolios to manage them? 

The STOXX^® Europe 600 index is a well-diversified index offering broader coverage of more European markets and industries, so it provides another angle to get involved in the European equities market. A trading strategy versus the more well-known EURO STOXX 50^® futures could be interesting at times.

We are (hopefully) at the top of the interest rate cycle and nearing the bottom of the economic cycle. How has investor sentiment changed ahead of this turning point? 

European investor sentiment bottomed out during the first week of November and has been recovering since, pulling markets up with it. Both this week’s the recent minutes from the Fed and the last ECB rate-setting meeting last week should hopefully confirm that central banks have reached the top of their interest rate cycles. This will help investors’ mood recover from the lows of “higher-for-longer” to the more optimistic “not-high-for-much-longer” consensus. There are already signs that this is happening, with market breadth recovering from the lows of the uncertain summer months. Over 50% of the STOXX^® Europe 600’s constituents beat the benchmark in three of the last four weeks. This increased breadth and dispersion across index constituents is good news for active managers. This is also happening while market risk remains well below its long-term median. This type of environment is well suited for generating alpha in the cash market through stock selection while hedging any sudden market risks via the derivatives market, at a low cost. We should also see a return of relative value strategies that aim to sell over-valued stocks and buy under-valued ones. At the index level, the prolonged period of risk aversion has made the EURO STOXX^® Banks index a lot more expensive than the broader STOXX^® Europe 600 index.

Investors can trade futures on the EURO STOXX^® banks, STOXX^® Europe 600 and EURO STOXX 50^® indexes during Asian trading hours. The extended trading hours allow for round-the-clock trading of European exposures from Asia and include MSCI and VSTOXX^® index, allowing for quick responsiveness to global market conditions.