For professional investors and advisers only
Schroder ISF* European Opportunities
Fund Manager Commentary
Covering May 2016
Fund Manager
Performance
Steve Cordell
The fund returned 2.5% in May compared to the MSCI Europe index
return of 2.3% 1.
Market review
The fund modestly outperformed the MSCI Europe index which rose 2.3% as the market rallied hard after a poor first
week. The equity market was highly correlated with the US economic data surprise index. As the data firmed, so did
the rhetoric from the Federal Reserve (Fed) about a rate hike, so up went the dollar, and down went commodity
stocks, which were the losers this month, reversing last month’s trend yet again. Metals & mining, oil & gas, and
marine all featured in the worst performers, along with internet retailing. Winners featured road & rail, biotechnology,
household durables and IT, most of which are dollar beneficiaries.
It feels we are all currency traders theses days, as the dollar, sterling or the euro seem to drive earnings and share
prices more than most other factors combined. The Fed’s chances of a June rate hike had risen to around 33% by the
month end, only to collapse back down to a mere 4% a few days into June after a shockingly low non-farm payroll
number. US bond yields collapsed back down to the lows of the previous month as the US manufacturing ISM fell to a
mere 50.8, thanks to new order growth fading. It would appear the robust US growth that everyone is forecasting for
the second half of the year is looking increasingly in doubt. The US purchasing managers’ index (PMI) survey new
orders/ inventory ratio even fell back below 50 for the manufacturing sector, as both new orders faded and inventory
rose. This is hardly the right backdrop for a rate hike, and so all eyes will now turn to the next risk in markets, the UK
referendum on Europe and the Spanish elections.
The Brexit debate is essentially a vote on whether the economy or sovereignty matters more. The weakness in the UK
economy over the last few months is unsurprisingly getting worse, but the most recent PMI survey suggests a
reacceleration maybe around the corner. How businesses can assess the outcome of the referendum is a moot point,
but the bookmakers are still suggesting a 70% probability of the UK remaining in the EU. With only two weeks to go,
maybe business is just getting back to business after all, but recent polls and public debates seem to show increased
support for Brexit. It is proving harder to argue against the principle of sovereignty than the facts and figures of the
economy, which are always in dispute.
The Spanish elections are probably just as unpredictable, if you believe the polls. The real losers seem to be the
socialists, where the more radical Unidos Podemos (ex Communist) party have stolen the initiative from the traditional
PSOE, by becoming the largest party on the left of centre. With no single party likely to gain a majority again, it will
either be a left wing or centre right coalition that leads the country. Expect markets to react badly if the left wins, and
we retain a cautious stance to Spain as the uncertainty could well continue into July as coalition talks are likely to be
tricky.
At least the US seems to have chosen their presidential candidates, and maybe the success of Donald Trump is a
lesson to investors about the risk of populism becoming mainstream. Italy, once again, is finding more support for the
Five Star movement, and traditional parties are struggling to convince voters that the status quo is the best option all
across Europe. Euroscepticism is just as common across the eurozone as in the UK.
Fund review
Looking at the attribution for the month, we gained in stock selection (68bps) and lost 34bps in style group selection.
Stock selection was best in financials and growth. The latter was thanks again to Pandora, which raised guidance and
added 40bps all by itself. We have used the recent strength to take a little more profit. The financials saw good
contributions from Deutsche Boerse, which upgraded synergy targets from the planned LSE merger; from
*Schroder International Selection Fund is referred to as Schroder ISF.
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Source: Schroders, Share class: A Acc.
Schroder ISF European Opportunities
For professional investors and advisers only
Ageas, which beat forecasts in Q1; 3i Group, which also beat guidance; and Societe Generale, which bounced
along with BNP Paribas as risk appetite returned.
The worst hits came from commodity cyclicals Rio Tinto (-34bps), Cairn Energy (-26bps) and PGS (-17bps) as
investors reversed engines from last month. Our overweight added to the negative contribution, making it the worst
overall style group at -64bps. Consumer cyclicals also suffered from poor stock selection, with Thomas Cook (10bps) down on poor trading and Rheinmetall (-13bps) down on weak auto margins.
Activity in the month included adding to Nestle ahead of a solid investor day, buying Thyssenkrupp, ahead of an
upgrade cycle, as steel prices rise in Europe, and switching banks away from Spain, by selling Santander to add UK
exposure in the form of Lloyds.
Fund strategy
We are looking to reduce our industrials at their relative high on the back of the weaker PMI data and cut our
financials back as the earnings momentum remains firmly negative in this area. We are looking to add to UK and Irish
banks on weakness ahead of the referendum. The only part of the market with upgrades is commodities and so we
are adding here after last month’s weakness. The consumer remains more vulnerable at this time of political
uncertainty than either commodities or industrials where prices are rising, so we are moving down here, especially in
autos, and in retailing, via Pandora. Political risk is being hedged by our underweight in utilities and banks, especially
in Spain, where the risks are highest.
Our view of the next twelve months is becoming increasingly gloomy as regards the US equity market. The rise in oil
prices and interest rates is likely to cause a recession in 2017, if it doesn’t begin of its own accord in 2016. The labour
market is showing signs of fatigue and corporate profits have peaked. The next move in labour markets could be
down, which would mean the recession is around the corner. We are not there yet, but we are increasingly on the
lookout for signs of trouble. The US credit market is currently not signalling concern because oil prices have risen, but
US long bond yields are worryingly low and yield curves are flattening. This is not a good sign and the equity market
needs earnings to stop falling soon or we will run out of road and off the cliff.
Steve Cordell – June 2016
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