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Emma Wall: Hello and welcome to the Morningstar series, "Why Should I Invest With You." I’m Emma Wall, and here with me today is Rob Burnett, manager of the Neptune European Opportunities Fund.
Hello, Rob.
Rob Burnett: Hi.
Wall: So we’re here today to talk about how macro events influence the markets, in particular, we have had ECB decision last week cutting interest rates. Stock markets did react. Is this something that we should take into consideration when investing?
Burnett: Definitely. Monetary policy and macroeconomic events are enormously important for markets. And one of the simple ways of understanding the transmission between monetary policy and the real economy is the interest rate for an economy.
So if interest rates go down or if loan rates go down, people can borrow more cheaply. They’re more incentivised to spend that can obviously catalyse a stronger economy, and therefore, these things are extremely important and should be considered very carefully.
Wall: Because GDP is not always a good indicator of where the market is going to do well. In particular, if you look at China despite the fact that China's GDP has slowed, it had some periods of underperformance, but you're saying there are other key macro indicators which perhaps do have an influence on markets.
Burnett: GDP is a lagging indicator. The market is normally up to speed with what the GDP is in the coming quarter. The market is more preoccupied with the rate of change of the economy and the momentum. And so, in this example of the ECB cutting rates recently, that’s going to have an impact in affecting the rate of change of the economy tomorrow versus current output. And that is what preoccupies markets more, the rate of growth, in the next six to 12 months.
So we would say GDP isn't necessarily correlated with equity market returns, but new long-term GDP in the next two to three, four years is definitely a powerful source of support for markets if an economy is growing strongly.
Wall: So using the indicators that we have at our fingertips today, what would you say investors can expect from Europe in the medium term?
Burnett: We're pretty constructive on European equities for many reasons, not least, because we do think the economy is going to continue to recover. The major element of, sort of, the turning point of the economy was really about a year ago when a lot of the Eurozone pulled out of recession. And what we had in the last 12 months is a slight stop and start kind of setup, rather like we had in the U.K. about three or four years ago.
And funnily enough, the European Central Bank is carrying a policy quite similar to the U.K. did a couple of years ago. And we know what happened in the U.K. in the last 12 months, it's rebounded quite strongly as is the housing market. We anticipate a similar outcome in Europe. And so we do think the setup is very constructive for the economy and for markets right now.
Wall: When this region is experiencing this economic recovery, all those certain sectors that people should be looking out for which will benefit more?
Burnett: In Europe today, the most cyclical sector, in fact you can almost call it hyper-cyclical, is the banking sector. So, just as this was the major area to avoid in the crisis and it suffered enormously, it is the major area to benefit from a better economic outcome and again going back to the ECB, the policy announcements yesterday – or recently were especially beneficial for the banking sector.
So we would recommend focusing on the banks as the major sort of beneficiary of this improvement within the European economy.
Wall: Because they’re basically going to paid to lend now, aren’t they?
Burnett: Yes. Almost. The way to understand it I would put it is that the ECB is going to give them very cheap funding. So normally how does a bank generate funding? It gets it from its depositors, and it pays interest to those depositors. And, of course, that still takes place. At the moment, most European banks pay around 2% interest on a term deposit. The ECB is giving the money at 15 basis points as in 0.15%, and so this is a massive reduction in their cost of funding, and therefore, it will enable them to lend quite cheaply to the economy. And so, this is especially powerful for the banking sector, this source of ECB money.
Wall: And other than the banks, would you perhaps have a bias towards domestically-focused stocks because as that domestic economy rises and improves, they will also benefit?
Burnett: Yes. In the last decade, we had invested with a focus on companies with a global reach, kind of, the companies exposed to global growth whether it’s Chinese growth or Brazilian growth or even U.S. growth. We had a predisposition to invest in those companies because the outlook was exceptionally strong.
Today there is an incredible valuation opportunity that is a discount in companies exposed to Europe. They’ve done poorly in the last five to seven years, and as a result the equities are very cheap and expectations are pretty low.
And so where do we look for outsize returns today? It is exactly that domestic-exposed kind of company with high sales to the Eurozone. That's where we think most of the upside will be located.
Wall: Rob, thank you very much.
Burnett: Pleasure.
Wall: This is Emma Wall for Morningstar, thank you for watching.
