- All About Alpha
We enter 2016 in a different mode to the last number of years. Price Earnings expansion has driven equity markets as central bank policy has encouraged investors towards riskier asset classes. This era of liquidity is now drawing to a close (albeit not in Europe) and investors should expect some shift in market dynamic. We believe the focus will now be more on fundamentals, less on policy, more on relative performance, less on absolute, more on risk-adjusted returns, less on total returns. As we migrate further through the cycle, opportunities will be less present and the need to be selective more relevant. With overall return expectations lower, we believe savvy investors should consider investments designed to generate additional alpha.
- Due a Change in Leadership?
It’s not just many European countries that might see their leadership change in 2016. After many years of “defensive growth” outperforming, better economic growth in Europe combined with the prospect of higher global bond yields could lead to a change in market leadership. “Value” areas of the market may see greater support.
European Sectors Correlation to U.S. Bond Yields (100%=1):
Source: JPMorgan as at 4 January 2016
That said – we believe the risk of being too simplistic at a time like this could be fatal. Firstly, “Value” has many definitions. Secondly, “Value” is currently heavily skewed towards commodity-related areas of the market, which arguably have little support. In our mind, to capitalise on this potential shift, investors should align “value” with earnings growth potential. In short, good stock selection.
- Earnings Growth Supports Pro-Cyclical Stance
Against the backdrop of ongoing ECB support, a lower FX rate and ongoing development in both European and Global growth, we believe earnings growth will be evident in the Eurozone market in 2016. Our base case is 9% EPS growth, which should allow the market to move higher in absolute terms. On a relative basis, Europe could outperform other developed markets. Yet again, this earnings growth will not be market-wide with some companies better placed than others to deliver. In our view, to believe in the European Equity story, you need to believe in earnings growth. To benefit from this earnings growth, we believe you need to be exposed to cyclical companies that are more likely to deliver. It is, however, unlikely the European market can de-couple from what is happening externally and concerns regarding global growth will dictate volatility and market direction at different points along the way. In our view, truly fundamental investors will seek exposure to cyclical areas of the market capitalising on this prospect of better earnings, but identify companies with strong balance sheets, which should provide some resilience to market volatility.
 Alpha: The additional return above the expected return of the beta adjusted return of the market; a positive alpha suggests risk-adjusted value added by the money manager versus the index.
 Price-Earnings Ratio – P/E Ratio:
The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative to its per-share earnings.
 Correlation: The degree of association between two or more variables; in finance, it is the degree to which assets or asset class prices have moved in relation to one another. Correlation is expressed by a correlation coefficient that ranges from -1 (never move together) through 0 (absolutely independent) to 1 (always move together).
 Pioneer Investments as at January 2016