Exposure rates of the Dorval Asset Management Range – 29th April 2022
Many financial analysts feared that the earnings reporting season would unveil severe pressure on corporate margins, yet most companies have reported that they could pass rising costs onto sales prices: this is exactly how inflation spreads. This situation acts as a reminder that corporate profits are broadly ‘indexed’ to inflation. So despite the war in Ukraine, forward EPS on the MSCI Europe has gained 10% YTD, while the index has shed 7.5% (cf. chart 1).
This difference between projected earnings and share prices can be easily explained. Investors quite rightly believe that companies will struggle to pursue their performances as a result of risks looming over their future growth. The acceleration in inflation is pushing up the cost of living for consumers and also driving up interest rates, which will end up denting the economy, with much longer lead times. This combines with a now very tangible risk of disruptions to Russian gas supply – which have already materialized for Poland and Bulgaria – with this type of power supply much more difficult to diversify than oil and coal. Rising inflation since the start of the year and the escalation in sanctions therefore warrant the decline in equity market valuations this year (cf. chart 2).
Do European P/E multiples now offer an opportunity? This is a particularly timely question as real interest rates – i.e. after expected inflation – for long-term bonds remain extremely negative in Europe (-2% for the German 10-year). However, current P/E multiples and the risk premium vs. bonds clearly cannot shelter the equity markets if the probability of a major economic slowdown – or even a recession – does not decrease again. In the United States, these probabilities will hinge first and foremost on the pace of the inflation-wage spiral, while in Europe, they will be dictated by the speed of the escalation in sanctions and the credibility of the continent’s response to the challenge from Russia. Europe will need to show that it is moving towards a “whatever it takes” approach to energy, which will add to protective financial measures already announced in several countries, such as France, Italy and Spain, etc.
In our flexible funds, we maintain our moderate and highly diversified exposure to developed country equity markets, and pursue our investment in the energy transition theme.