Grey swans prompt market rethink

Grey swans prompt market rethink

There’s plenty to chew over this week. The rising possibility of Scottish independence, the ECB’s decision to go (almost) all in to avert deflation and stagnation and disappointing US jobs numbers have forced an investor rethink.

Break-up and deflation fall under the category of “grey swan” events – conceivable events, with unpredictable outcomes – “known unknowns”, as it were. The net effect of this enhanced uncertainty has been to push back UK and US interest rate hike expectations and to weaken both sterling and the Euro against the dollar. The US jobs recovery might be flagging, but that feels like small beer in this company.

And so the uncertainty drags on. Certainly in the Eurozone, where its saga appears to have many more acts. Perhaps even in the UK, if the Scottish referendum vote is very close. UBS have raised the chance of a third ‘Québécois’ outcome – a scenario that falls between a decisive Yes/No, where markets continue to price in the risk of further referendums.

ECB last throws…and last throes?

The Economist wrote last week that the risk that a country decides to ‘storm out’ of the Eurozone is ‘rising’. Still? Yes, this came before the ECB’s latest actions, but the risk is still there.

Of course, it’s not all gloom across the region. There are positive flickers of life, from the Irish recovery to signs of recovery in Spanish house prices. However, the bigger economic picture is truly alarming. Last week, the ECB once again downgraded its 2014 growth and inflation forecasts to 0.9% and 0.6% respectively – averages that conceal pockets of stagnation and deflation. In this context, the action taken by the ECB to lower interest rates and begin an ABS purchase programme is an understandable, normal policy response – with the added bonus of weakening the Euro. However – as we’ve said before here – the global context is far from normal and we’re far from convinced that the chief problem in the Eurozone is the price or availability of credit.

According to JP Morgan, the G4 banking system already has excess reserves of around $4.5t i.e. reserves commercial banks have with central banks in excess of what they need to meet usual liquidity needs. There’s a risk that the ECB’s actions could further perpetuate a culture of dependency and create a disincentive for reform. Without structural reform, growth prospects will remain limited and businesses won’t demand more credit.

And, is this action the ECB’s last throw of the monetary dice? Interest rates can go no lower. Hints of resistance to ABS purchases raise the possibility this is as far as the ECB can go. What if it can’t deliver on QE hopes?

The Eurozone still needs to act radically on debt and to take action to drive the structural reform necessary to promote strong growth and avert deflation. The ties that bind the Eurozone go beyond finance. They weave back into hundreds of years of turbulent history and are rooted in the belief that closer bonds promote peace. However, this shared history can’t hold the region together indefinitely without an economic imperative. Electorates are already wondering what the euro ever did for them – they need growth and jobs to convince them to stay.

Private equity outperforms

Liquid markets have certainly been a boon for private equity. EY’s ninth annual European private equity study shows 77 exits in 2013, versus 61 in 2012, aided by revival in IPOs and secondary markets. IPO exit activity reached its highest level since 2006 in 2013, with 13 companies floating compared to just three in 2012. This rise in floats grabbed the headlines, but secondary activity also increased as debt markets opened up. Last year, 55% of exits were to other PE firms’ companies — a notable increase from the 38% recorded in 2012 and the highest share of exits since 2007. The rate of corporate purchases remained low in 2013 – in part due to competition from these other avenues. However, exit activity has also been strong in 2014 and, with a strong pipeline, should continue to be so in the rest of the year.

Our study also highlights the positive effect of private equity ownership. The data shows PE creating superior financial returns for investors, even after discounting for additional leverage and stock market performance. The most important source of PE outperformance came from faster profit growth, driven by initiatives to increase revenues and operational efficiency. Gross investment returns from PE-backed companies outperformed comparable publicly listed companies by a multiple of over three times between 2005 and 2013.


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