European market in need of “rewiring” says CIO

Published on 13 May 2024

Alexander Morris, chief investment officer at F/m Investments

There are growing concerns for the European market as it tries to compete with the US and encourage investment in the region. Alexander Morris, chief investment officer at F/m Investments, says Europe requires a fundamental “rewiring” which could take years to resolve.

In this episode, Morris also unpacks why he expects “an exciting” week ahead and the potential for surprises in EU inflation. He looks at the revival of confidence in equities markets and a shift to taking on risk, in addition to managing over-concentration in the heavily weighted US tech sector during earnings periods.

Despite the backdrop of a high-interest rate environment, market uncertainty, and relentless geopolitical issues, Morris also discusses his views on why markets are still experiencing historically low volatility and how trading desks should be scrutinizing the increase in company buybacks.

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Interview Transcript

Jo Gallagher, presenter Macro factors are still very much dominating market activity. Given that, how would you be advising trading desks going into this week?

Alex Morris You know, this week is setting up to be a little more exciting than most. We’ve gotten through a lot of Fed speak. We now also had a surprise, perhaps rate cut by the Swedish central bank, the Riksbank, which has often raised or cut to its own drumbeat. So we shouldn’t take that as a harbinger for too much more than that. But we see a little bit of thawing in the English central bank.

And if we start looking at the time plots of cuts and hikes relative to US and Europe, we’re going to see that, you know, that maybe inflation is going to come back a little bit in Europe, which is great news, because we know what that playbook looks like from the Fed.

In fed speak, we kind of know what to play across other major indices as that works. But I think the key messaging from last week was the economy is pretty good across the globe.

We’ve had great earnings, a good pull through the S&P, Dow, Nasdaq or reproaching all-time highs. And I think you can pretty much just stay risk on and push through more or less, as we have for the last couple of weeks, and expect that not much is going to change.

Jo Gallagher, presenter Given the backdrop of a high interest rate environment, market uncertainty and geopolitical issues—why are we still seeing historically low market volatility?

Alex Morris Now, I sometimes wonder if the market is saying what interest rates, what instability? It doesn’t seem to care much. And I think we go back to basics right? The equity markets are an expectations market. And we measure volatility through price movement.

We also measure volatility through options and other things and the VIX is sort of an interesting measure of how we do that. But what we’re really seeing from a volatility standpoint is expectations are pretty much the same across the board. And that we’re all more or less hoping that the same thing is going to happen. And there aren’t that many folks on the counter side of the trade that we need to take.

High interest rates or higher, we should say, they’re not high by historical measures, have proven that rates didn’t have to be at or near, or in some cases below zero for the economy to be strong or the equity market to be profitable for others.

As we look towards a normalizing, perhaps next five-year rate environment, it’s unlikely to be zero. It’s unlikely to be five or six. It’s where do we fall between two and three or four? And how do we move in between that range that folks should start to get ready for? And on the whole, the economy has proven it can sustain thrive at zero. Not a surprise, but it can actually sustain and thrive at five, which is a good thing.

We’ve been working for years to build a resilient, fundamentally stable, and sound economy. And we did it. We shouldn’t be upset or worried by the results of the exact work we’ve been trying to do since the GFC (global financial crisis).

Jo Gallagher, presenter Spell out your views on the divergence between the U.S. and European markets, including the IPO space. And how does that fit into your investment outlook?

Alex Morris So I think both markets have been pretty well deprived of IPOs. In the US we’ve been talking about how maybe ETFs are replacing that. But an ETF of the Mag 7 isn’t a replacement for any of those companies.

Europe’s done a bit better. We’ve had a couple of interesting names come to market. They’ve priced well. They’ve immediately had some return. But long term both markets are going to need to work out how do we get some fresh blood into the markets and into the economy?

Practically, now we look at the underpinnings of what’s happening in the US market versus European economies, and we just don’t see that large tech presence in Europe. And as a result, we look at the valuation gap and we say this year it’ll be the year that it closes itself. But we’ve been saying that for five,10, 15 years now. And the mean reversion is a mathematical phenomenon, it’s not a law of nature. And I don’t know that we’re necessarily going to see that change.

Some of the largest companies in Europe are going to continue to be profitable, continue to have great dividend yields, and continue to do exactly what their local markets want from them, and in particular, their local pensioners want them to do.

The names that dominate European bourses tend to be financial services, insurance, real estate, and businesses that have regular cash flow but generally don’t stick out for innovation. Most of the companies that are truly innovative, right? We look at Spotify in Sweden.

Those names tend to either list quickly in the US or tend to find alternate paths. And when they come to the market, they’re up against some stalwart names that have been around for centuries and just can’t quite make that innovative leap. And I think unfortunately, that’s going to stay the same for this week, for next week, for next month, and probably for next year.

That’s going to require a rewiring of management and a rewiring of how the local economy wants to work. That is going to take a very, very long time.

Jo Gallagher, presenter How do you manage concentration risk, particularly during volatile periods like earnings?

Alex Morris Well, it’s much harder now than it used to be 10 years ago. The S&P 500 was just naturally diversified. So you could just take on some beta risk and you’d be fine.

Now with the Mag 7, concentrated in such a large percentage of it. We really do need to think about the S&P 493 or the S&P everything else.

There are some great companies in there. I don’t mean to make everything else sound as pejorative as it does. If you’re looking sector by sector, we like the defense sector. You know, there are a few hot wars going on, even if the market has somewhat ignored them.

I don’t think to manage concentration risk, we need to go to value. Folks who’ve said this is an overconcentration of growth. You should look at the value indices. They have a concentration in these companies as well. It is over-concentrated still. So it’s really how do we just focus on the core and to some extent given where markets have been. Maybe not worry too much yet.

We’ve seen a few stumbles in some of these names. They’re not fundamentally flawed, they’re just running out of some momentum, but they will get it back. That’s just the ebb and flow of momentum trading.

But if you had a chance to take profits, we certainly have seen Warren Buffett do that famously and a handful of others. It’s an okay place to be. Our risk metrics were always 6% to index risk. We’ve never taken those off, and we just keep funneling those funds back into the, you know, slightly less momentum-driven part of the market. And we’ve been rewarded for it. And I think others will too.

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(European markets, European, Markets, Rewiring, IPOs)