- Gap widening between gauges of equity and corporate-bond risk
- Timing of ECB QE helping stocks more, says Carmignac Gestion
As optimism grows for increased stimulus from the European Central Bank, nervousness about owning the region’s stocks is receding faster than for corporate bonds.
While risk in the investment-grade credit market fell by the most in two years in October, it slid even more for euro-area equities, spurred by ECB President Mario Draghi’s indications that officials may consider more easing in December. The gap between the gauges for the two markets last month widened to the most since March 2014. A boost will benefit stocks more as it strengthens support for the economy, while upside is limited in corporate bonds, said Royal Bank of Scotland Group Plc’s Alberto Gallo.
“There is some excitement in the market after Draghi’s comments and equity people react more quickly in a more liquid market” said Gallo, head of macro credit research at RBS in London. “Credit had already been very well priced, spreads can’t go to zero, whereas stocks can go a lot higher, as a lot of the QE effort will also lower the euro. Earnings could improve more.”
Investors have favored stocks over bonds, pouring $106 billion into European equities since the start of the year. By comparison, they have put $6 billion in investment-grade credit markets and withdrawn $1.8 billion from high-yield bonds, according to an Oct. 30 Bank of America Corp. report citing EPFR Global data.
The Euro Stoxx 50 Index jumped 10 percent last month, following its worst quarterly rout in four years. The gauge is on track for the best annual gain since 2013. Meanwhile, October returns of 1.4 percent for euro-denominated investment-grade corporate bonds, the best since January 2014, weren’t enough to reverse annual losses, according to Bank of America Merrill Lynch index data. Bond yields have been declining since the peak of the global financial crisis in 2008, when they reached 7.6 percent.
“Equities win the relative game,” Didier Saint-Georges, a member of the investment committee at Carmignac Gestion SA, said at a press briefing in Zurich. “The timing of the ECB’s QE helped the equity cycle more after credit spreads tightened quite a lot. Also, there’s still hope Europe recovery will pick up, which would benefit equities.”
The VStoxx Index, which measures volatility in the Euro Stoxx 50, tumbled 36 percent in October and is about 3 points away from this year’s low. Even after sliding 20 basis points, or 22 percent last month, the Markit iTraxx Europe index is still above its one-year average. The gauge measures the cost of insuring against losses on the debt of 125 investment-grade companies, including Volkswagen AG, Anglo American Plc and Banco Santander SA.
The Markit iTraxx Europe index advanced 0.9 percent at 5:13 p.m. in London, while the VStoxx gained 3.4 percent.
EFG Asset Management’s Hilary Wakefield says the drop in stock swings is driven by investors picking up shares cheaply after a summer rout triggered by concern over China’s slowdown. Even after the rebound, Euro Stoxx 50 companies trade at an average of 15 times estimated earnings, cheaper than an April high of 16.6 times.
“What’s the driver for the equity market? Earnings so far have been OK, but hardly very compelling,” said Wakefield, head of portfolio management at EFG in London. “That’s complacency that has come in, rather than people being more optimistic.”
Investors are still betting that the ECB’s moves will weaken the euro more, helping shares of exporters. European carmakers were the best performers among industry groups in October. Further easing will also bring down volatility from current levels, according to Ion-Marc Valahu, co-founder and fund manager at Clairinvest in Geneva.
“There’s less risk in equities because people can easily get out of the market,” said Valahu. “In the credit market, there are liquidity issues because nobody is a buyer of last resort.”