Erste Asset Management - Blog

Peter Szopo

Peter Szopo has worked as chief equity strategist at the Erste Asset Management since March 2015. Before he already worked as a consultant for equity fund management at Erste Asset Management for Central and Eastern European equity markets. From November 2009 to April 2013, he was head of the research department at Alfa Bank in Moscow.

After his research work at WIFO (Austrian Institute of Economic Research) from 1978 to 1990, he worked as a securities specialist in various management functions at internationally renowned investment banks. During this time he held the position of Head of Research at such institutions as Creditanstalt Investmentbank, UniCredit Bank Austria, Robert Fleming Securities, and at Bank Sal. Oppenheim.

Along with his analysis activities, he worked from 1997 to 2000 at Eastfund Management as the fund manager for Central and Eastern European equity.

Peter Szopos Posts
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Peter Szopo am 20th June 2016

Brexit update: Will they stay or will they go?

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Less than a week is left before the British electorate will decide whether the United Kingdom should remain a member of the European Union (the Bremain scenario) or leave the union, an outcome known as Brexit. Two months ago, when we started covering this event in a series of blogs (see here, here, here and here) Brexit seemed unlikely, markets were relatively calm and the political debate in the UK was as civilized as one would expect in one of Europe’s most mature democracies. In April and May, the probability of Brexit to happen even dropped, the British pound recovered some of its previous losses, and the Eurozone volatility index (VSTOXX) almost halved.

Since the end of May, however, the situation has massively changed: The likelihood of Brexit has increased again, investors are getting nervous, and the political debate in the UK has turned nasty. What has happened?

 

Opinion polls and betting odds point to a rising probability of Brexit

Online polls have shown a majority for Brexit for some time, but more recently also the lead of the Bremain campaign in telephone polls has been evaporating. Moreover, also in betting markets the probability of Brexit rose temporarily to 40% before falling back to around 30% in response to the public reaction to the murder of a British pro-EU politician last week.

While these developments suggest that the referendum will be a close race, on balance, Bremain still seems more likely. Election experts emphasize that typically more than 20% voters make up their mind only days before the actual vote, and that late-deciders tend to vote for the status quo. From previous cases (Quebec, Scotland) it is known that the final swing toward the status quo could be 5-6 percentage points.

One important factor will also be turnout. Since Brexiters supposedly are more committed to their cause, the general view is that turnout needs to be at least 55-60% for the Bremain vote having a chance to win.

01

 

Markets under pressure in June ….

While currency markets started pricing in Brexit-related risks already in the fourth quarter of 2015, equity and fixed income investors were complacent for a long time. This changed in June. The Euro Stoxx volatility indicator climbed to 40, and British and European stock markets moved sharply down, losing 5-7% in the first half of the month.

Against the backdrop of elevated risk, it also became clear which assets investors consider as safe havens to escape Brexit-risks:

  • German, US and UK sovereign yields resumed their descent, with bund yields falling below zero, yields of UK 10 year gilts hitting a multi-decade low and US 10 year treasuries falling to a four-year low.
  • The Swiss Franc appreciated 3% against the Euro over the past four weeks, and the Japanese Yen gained more than 5%. Surprisingly the US Dollar, normally also among the safe haven currencies, remained weak, suggesting that the main driver at present is the Fed, not Brexit-risks. However dollar strength will likely return, if and when the Fed resumes its tightening stance.
  • Also gold, which had retreated in May, staged a comeback, nearly scratching at the level of USD1,300/oz.

02

 

… but Brexit is not fully priced in

Given current polls and betting odds, Brexit is certainly not the base case on which the majority of investors operate. Thus, recent market swings clearly have signalled in which direction assets were to move in case Brexit happened, but they are not reflecting the full impact of this event. The FX options market implies that the British Pound will devalue by around 7.5% against the Euro and around 8.3% against the Dollar in case of Brexit (Source: Bloomberg). This would push the cable (GBP/USD) down to just a shade above 1.30, a level not seen since the early 1980s. (The author’s own feeling is that the implied devaluation of the Euro against the Dollar of less than one percent may be too benign. It reflects the Fed’s current caution on interest rates, but if Brexit really happened the dollar’s attraction could strengthen regardless of the Fed’s policy stance.)

03

More importantly, the pressure related to Brexit would certainly not be limited to currency markets. With the jump of the likelihood of Brexit from around 25% (end of May) to 40% (June 15) triggering an increase in the equity volatility in Europe to 40 (VSTOXX), it is not difficult to imagine that the volatility index could easily exceed levels of 50 -55 in case of Brexit – a level that was last time reached in 2011 in the course of the second Greek bailout.

04

Both the Euro Stoxx 600 and the FTSE 350 have already shed some 7% from their recent highs in the second quarter. In case the referendum results in a win for the Brexit campaign, both European and UK stocks will move lower. Given the recent pattern it seems that the event-risk is of the same magnitude both for UK and European equities.

Over the past ten years, a weekly change of ten points in the implied volatility index (e.g. from 20 to 30) was associated, on average, with a drop of 5.8% in the Euro Stoxx 600. Thus, assuming that the implied volatility would spike to 55 from its current 38 (June 17) in case of Brexit – still a conservative assumption in my view – would trigger a fall of the Euro Stoxx 600 by another 10% in the near-term.

05

 

Asymmetrical risks

Of course, in case Bremain prevails we can expect a relieve rally, i.e. a switch into risk-on mode with stocks and other risk assets rebounding, volatility falling and the Euro and the British pound gaining. The latter could easily return to 1.50 versus the dollar, and possibly climb to 1.55 in the weeks following a positive outcome of the referendum.

But it is important to note that, while the event – the referendum itself – is binary, the same is not true for its impact on financial markets. The distribution of expected returns is skewed to the downside.

There are two reasons for this: First, the uncertainty that will unfold in case of Brexit is simply much bigger than the certainty gained in case of Bremain. While a decision for Brexit will take the UK and Europe – politicians, the business community, investors and everybody else – deep into unchartered territory related to the long-term risk of a crumbling EU, a decision for Bremain will at best restore the status quo ante, which means that global growth concerns, Chinese macro, the Fed and the earnings outlook will regain the control over European markets. Negative developments in any of these areas could quickly end the Bremain-relief rally, in case it happened.

Second: A tight outcome, even if it will be in favour of Bremain, would not solve the massive ideological split among British conservatives, and could create a government crisis. More importantly, a tight outcome would not fully remove the uncertainties about the future of the EU. It would still not calm the anti-EU movement in the UK and it could encourage secessionist movements in other member states to press for a vote on EU membership.

It seems that times for Europeans continue to be interesting – which, as we learnt from the Chinese, is a curse not a blessing.

 

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Peter Szopo am 20th April 2016

Brexit: Breakin’ up is hard to do – Part IV

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Stock markets not impressed – so far

While the debate about Brexit is getting more intense (just a day ago the UK Treasury released its warnings) and the Pound Sterling is trading near historical lows as the referendum is approaching, the UK equity market has not shown any signs of stress. Its valuation premium to the Euro Stoxx 600 (in terms of the forward P/E) has not narrowed and its discount to US equities is lower than any time in recent years, as we pointed out in our previous blog.

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Peter Szopo am 19th April 2016

Brexit: Breakin’ up is hard to do – Part III

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What financial markets are telling us about Brexit

The UK’s exit from the European Union – known as “Brexit” – would be a major economic and political event for the UK, Europa and the wider world. While Brexit is not the most likely outcome (see the first blog in this series), it is a real possibility, raising questions, how financial markets will respond. In this column we present some evidence on how Brexit fears have affected markets so far and our thoughts what we can expect going forward.

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Peter Szopo am 15th April 2016

Brexit: Breakin’ up is hard to do – Part II

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The economic implications of Brexit

Opinion polls and betting odds as well as the muted response of debt and equity investors suggest that Brexit – the UK’s exit from the EU – is not the most likely scenario. That said, it cannot be ruled out. For example, about a quarter of all opinion polls conducted in the UK since last autumn resulted in a majority for the leave-vote and there are some signs that the leave-faction is gaining ground as we pointed out in our previous blog on this topic.

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Peter Szopo am 13th April 2016

Brexit: Breakin’ up is hard to do – Part I

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The likelihood of Brexit

On June 23, 2016 the UK will hold a referendum. Voters will decide whether the country should remain a member of the European Union (the “Bremain”-scenario), or whether it should leave the EU (the “Brexit”-scenario). Arguably, Brexit marks the most significant tail-risk for European and global asset markets in 2016.

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Peter Szopo am 25th February 2016

Earnings season triggers downward revisions

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Earnings are key for equity investors, as also my colleague Harald Egger emphasized in this blog two weeks ago. This basic truth is even more relevant as usual at a time when a multi-year equity bull market has ended and a wobbly global economic backdrop is weighing on market sentiment. In this situation, corporate earnings can provide important clues whether current market turbulences are mostly reflecting top-down anxieties or something more fundamental in the corporate sector is going on, which will put pressure on valuations.

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Peter Szopo am 13th November 2015

Interest rate lift-off – Stay cool

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Following last week’s surprisingly strong employment report, the odds that the US Federal Bank will start raising its policy rate at the next FOMC-meeting in December jumped to almost 70%. Of course, 70% is still short of 100%, but most observers believe that something terrible must happen in the next four weeks to make the Fed reconsider, particularly in light of President Yellen’s statement in September that the FOMC’s thinking suggests a “call for a funds rate increase later this year”.

While the case for starting the lift-off remains a close call as Kenneth Rogoff pointed out, it has strengthened in recent weeks as US economic data have turned more positive relative to expectations, according to Citi’s economic surprise index. Most importantly, the improvement in the job market is continuing. The US economy has been adding, on average, 200,000 jobs in the non-farm sector each month in 2015.Read more

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Peter Szopo am 09th October 2015

The summer of our discontent

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Only in a few months we will likely know, whether the bull market that started in mid-2009 really ended in the summer of 2015. What we know, however, is that the headwinds that have emerged in recent months will not recede anytime soon. Another challenging quarter, it seems, lies ahead of equity investors.

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Peter Szopo am 13th August 2015

“Quarterly Capitalism” under attack

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If you thought “quarterly” was a simple adverb characterizing a regularly recurring activity, you may need to reconsider. A new term is making the rounds: “quarterly capitalism” – and in this context, “quarterly” stands for “short-term, myopic, greedy and dysfunctional”. In fact, the term was already invented four years ago by Dominic Barton of McKinsey and was swiftly embraced by, among others, Al Gore and Prince Charles to call for a major overhaul of current business practices of listed companies and fund managers. Recently the term has reached a new level of prominence after presidential candidate Hillary Clinton, in a series of appearances, complained that the “tyranny of the next earnings report” resulted in companies’ paying “too little attention on the sources of long-term growth: research and development, physical capital and talent”. Unsurprisingly, Mrs. Clinton’s proposed remedy consists of a mixture of higher taxes and more regulation.

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Peter Szopo am 20th July 2015

Turning more positive on CEE equities

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In searching for a perfect example of a sideways market one does not need to look further than at Central and Eastern European (CEE) equity markets. The CECE Composite, a Euro-based index of 23 Polish, Czech and Hungarian blue-chips (Bloomberg: CECEEUR), has been range bound for nearly four years, rarely trading outside a narrow range of ±8% from its mean over the period. A recent spike by 23% that started in January and lifted the index beyond this trading range was halted by the escalation of Greece-related risks. The only market in the region that has participated in the broader equity rally in Europe and the US in recent years has been the Romanian market.

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