April is the cruellest month, and this year it has been another month characterised by disconnection between the macro and the micro. Focus in the media has revolved around Spain, elections and the arguments between growth and austerity. Companies, by contrast, reporting on 2011 and looking forward from now to 2013, seem cautiously optimistic.
Spanish 10-year government yields troughed in early February at 4.58%, a fairly comfortable 2.73% above the equivalent German yield. The peak came at 6% in mid-April, a strained 4.4% above the German benchmark, since when it has eased to around 5.8%.
Investors faced – as they saw it – a complication of issues, from a bulge in peripheral eurozone government funding needs to increasing doubts that proposed austerity measures would get through the democratic process. The strains in the Spanish economy, with official unemployment at 24%, seemed even to cast doubt on whether austerity was the right policy to start with.
At about the same time the International Monetary Fund was publishing a regular update of its World Economic Outlook. The forecasts for this year for the southern European states are unsightly. Spain and Italy are expected to contract 1.8% and 1.9% respectively, though with growth turning positive in 2013. (blog continues below)
Although the global economy is expanding at a sub-trend rate, there are pockets of growth out there for us to exploit – emerging economies look set to grow at between 5% – 6% this year and even though the US will probably grow by only 2% – 2.5% in 2012, its recovery does finally seem to be becoming self sustaining with employment, housebuilding and construction activity there finally showing signs of picking up.
A third – but generally much quieter – strand of newsflow in April was the company reports for calendar 2011. The general tone was that revenues continue to rise and free cashflow remains strong. Capital investment and corporate restructuring remains fairly muted, but money is being spent, and deals are being done, where they add value. As is often said, company management read the same headlines as everyone else and are aware of the macro risks, but case by case the outlook sections of this year’s reports have been broadly optimistic.
Our own view is that we will continue to see episodes of risk aversion arising out of the eurozone, given that the underlying issues will take years to resolve fully. The fundamentals of global recovery, by contrast, remain on track, and this will continue to offer opportunities for good stock selection. Our policy for now is one of balance. We are looking for structural growth stories on the one side – those that are independent of the macro environment. On the other, we favour quality cyclicals with exposure to strong end-markets.
Daniel Nickols is manager of the Old Mutual UK Select Smaller Companies fund.