In the April 2010 edition of IPE, I wrote on these pages about my amusement that active managers always think it’s “a great time for active management”. I thought that uncertainties around the euro-zone, China’s economy, forthcoming elections and ‘geopolitical hotspots’ would keep us firmly in a ‘risk-on, risk-off’ world with stubbornly high market correlation.
Right on cue, the CBOE Implied Correlation index started rising and hit its peak 16 December 2011. Today, the euro-zone crisis is worse, the ‘hotspots’ have boiled over, China is slowing, and we have US, French and Russian presidential elections to look forward to in 2012.
But I think now might be a great time for active management. This goes beyond a significant pull back in the Correlation index. At regional level, US and European equity markets snapped sharply back into correlation through August and September 2011, and this was followed by a truly bizarre iteration of ‘risk-on, risk-off’ as, somehow buoyed by December’s EU summit, European equities began to pull ahead in Q4. But a couple of strengthening US jobs and weakening German growth data points later, and common sense is asserting itself: US equities have outperformed into the New Year.
Similarly, during 2011 the outperformance of German stocks over Europe ex Germany, and US stocks over Europe, were negatively correlated (-0.50 when regressing rolling three-month differentials). When the US outperformed, Europe sold off indiscriminately - Germany and all. Germany’s excellent start to the New Year reflects recognition of corporate Germany’s strengths above and beyond the euro-zone issue.
Those strengths include enviable industrial and exports biases. Horribly pro-cyclical, you might think. But as our special report on equity sectors reveals, a lot of those assumptions are crumbling away - and the market is starting to get it. Through 2011 the (export-oriented) Eurostoxx Industrials index struggled to maintain its outperformance over the (domestic-oriented) Utilities index - until the late-summer crash, when it capitulated completely. But not for long. Despite all the macro problems, the industrials have gone from lagging the utilities by 11% over the three months to October to leading them by more than 15% over the three months to mid-January.
Is this good news? It depends how you look at it. Investors are no longer swinging wildly from the ‘World ending, buy US power companies!’ trade to the ‘Everything fine, buy European factories!’ trade. But that’s because they’ve come to accept that, while the world isn’t ending, it isn’t going to be fine again for a long, long time, either. They are finally asking: ‘Which businesses have the quality and growth potential to preserve my capital through this multi-year re-adjustment?’ It’s good that stockpickers are thinking long-term again, and great they’re getting back to business. But we’re still a long way from business as usual.