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Cyclicals clear beneficiaries

Following the EC’s surprise resignation just days before a summit on key budget reforms, the euro is going to find it hard to regain investors’ perception that it has the makings of a strong currency. Disagreements between the ECB and social democrats throughout Eur-ope on the merits of which monetary or fiscal stance to take were only partially elevated by the departure of Oscar Lafontaine.
Politics, in theory, should have little impact on euro zone economic performance or monetary policy. Flow of funds, however, was predicted to result in significant cross border changes in portfolio composition. The theory is that pension funds in euroland would have to diversify their domestic as-sets, as their liabilities were no longer measured in their home legacy currency but in the euro.
The 27 companies that are found in all European and euro indices did out-perform a basket of currencies in the first few months. This effect might, however, have been the result of falling short rates and the same demand for large capitalisation multinational companies that was seen over the same period in the US. The high correlation between the pan European indices and the euro indices implied that there was no wholesale shift of funds from non-euro countries to euro currencies.
Individual states within Europe have very different structures. For example, Spanish equity markets are dominated by quoted financial and utility companies, while Germany has nothing classified in the oil sector. Diversification of assets would result in less variation between the sector mix between regional fund managers. This would involve massive portfolio rebalancing.
The FTSE European sector indices paint an interesting picture and answer the flow of funds questions that are raised by such discrepancies. It is quite clear from the graph that there are two distinctly correlated set of sectors performing in Europe in the first quarter.
The top performing sectors includes non-cyclical and cyclical services, both areas that have been truly liberalised by the EU and clear winners from the introduction of the euro. Non cyclical consumers goods are largely multinational in composition and are also beneficiaries of the new currency.
Daniel Broby is chief portfolio manager at Unibank in Copenhagen

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