Groupama AM

* * * Europe * * *

EuroBusinessMedia (EBM): What is your outlook for growth in Europe for 2012? Do you think we’re heading for a sustained recession?

Laurent Berrebi: No, not a sustained recession. We do think the euro zone is in recession, which will last till the start of H2 2012, so we forecast negative growth of 0.7% for full-year 2012. Considering the recession stems from lack of confidence in the euro system, it will rightly end when confidence returns, as economic policy measures bear fruit and a new economic governance emerges within the euro zone.

EBM: Do you see any prospect of the euro zone breaking up and a return to national currencies?

Laurent Berrebi: There is no prospect of the euro zone breaking up. We think it will continue to exist. The road to European federalism – since this is what will get us out of the crisis – will undoubtedly be tortuous, but we believe our politicians will be equal to the task. All in all, there should be no exit from the euro zone. At the same time, most euro zone countries will return to growth, though sharp disparities will remain between euro zone countries, like Italy, Spain and France, for example, with negative expected growth of 1.7%, 1% and 0.5% respectively, and Germany with positive growth of 0.3%.

* * * Banks * * *

EBM: Where do you stand on the banking situation in 2012?

Marie-Pierre Peillon: The situation can best be summed up by saying “Banks, banks, banks”. In our analysis of banking fundamentals, four main drivers still need to be considered. The first, and of course the most immediate challenge, is resolving the European crisis and particularly the question of the Greek PSI package. The second challenge relates to the anticipated growth in bad debt given the economic slowdown predicted in the euro zone. The third one, now well known and much discussed within the banking sector, is about deleveraging. The fourth and last challenge, which is the consequence of the third one, is about how the banks’ business model is to evolve in the future. What is reassuring about the banks right now is their liquidity situation. Of course, the system hasn’t yet recovered its full autonomy in terms of access to finance. Even after five years, unconventional measures are still needed from the ECB. Yet, thanks to LTROs, no new major liquidity crisis has hit European banks recently.

* * * ECB * * *

EBM: What is your view of the European-style quantitative easing currently being undertaken by the ECB?

Philippe-Henri Burlisson: Let me summarise this in three points. First, don’t call it European-style quantitative easing, since this would be beyond the ECB’s mandate. So it is a form of quantitative easing but don’t tell anyone. Second, and contrary to the Federal Reserve and the Bank of England, it is being done indirectly, i.e. through the banks. LTROs make it possible to pour liquidity into the banks, which then buy the government bonds that the ECB is not supposed to buy. Third, it’s very useful, since it helps reduce governments’ risk premiums while overcoming the refinancing problem that governments, banks and corporates might face in 2012.

EBM: Do you think the ECB can go even further?

Philippe-Henri Burlisson: That’s a good question, one on which the ECB gives zero visibility, unlike other central banks. But it is not an easy question, since the ECB’s regulatory framework is fairly difficult to read. But the answer is yes. The answer, and this is what the ECB has shown for 18 months, is that it has activated SMP or LTRO programmes whenever necessary. It has done so for three years, and it can do it again – or even do other things – if necessary. In other words, the ECB is being vigilant – a positive point for 2012.

* * * Rest of the world * * *

EBM: What is your outlook for economic growth in the United States this year and why are you confident that this economy will reduce its debt?

Laurent Berrebi: For the United States, we expect growth to hardly exceed 1%. We expect it to weaken somewhat in the first half of the year due to lack of consumption. Consumption will be hit by eroded purchasing power. But as we expect growth to reach 2% in the second half, it should average around 1% for the year. The backdrop to US growth remains debt reduction. US households, in particular, are being forced by their banks to cut borrowing, a trend we think will continue.

EBM: And what is your outlook for the emerging economies this year?

Laurent Berrebi: We did have some concerns about H2 2011 in the emerging markets. These have begun to fade, thanks to China experiencing a soft landing and managing it well. As regards the other emerging markets, we think they will take off again, given that Chinese growth should hold up and that the euro zone crisis is fading out. So we’re not worried about the emerging markets. Growth rates there should still be satisfying, though lower than levels seen in past years. China, for example, will grow by 8% after slightly more than 9% in 2011.

* * * Downgrading * * *

EBM: What are the repercussions after Standard & Poor’s recently downgraded various European countries?

Marie-Pierre Peillon: The Standard & Poor’s actions on Friday 13 January heralded two clear messages. First of all, S&P is passing judgment on policymakers’ failure to get to grips with the structural crisis that has now been plaguing us for more than two years. Second, these difficulties will affect the prospects for economic growth and the refinancing terms of these governments. And indeed, there are now many consequences, first and foremost for governments. Today’s ratings in the euro zone range from AAA to BB – not forgetting Greece, which is CC. Moreover, this rating universe is unstable, with 14 negative outlooks, which are likely to lead to further downgrades in the next 6 to 12 months. Finally, there are consequences for banks and corporates. Quite a few banks have been downgraded, or will be, on methodological grounds. And corporates like utilities or Italian telecoms have been or will be. The entire rating universe will therefore trend down. This will impact investors, who will be forced to invest in issuers that are much less secure, in a rating window ranging from A to BBB.

* * * Markets * * *

EBM: What is your outlook for the markets in 2012?

Philippe-Henri Burlisson: Our outlook is based on two main assumptions. First, we believe the euro zone will not disintegrate. We believe our politicians will succeed in getting us out of trouble, implementing the Greek PSI package, managing treaty changes and making progress towards the ESM. This is a pretty big assumption. Second, we believe in slower growth that will not end in a recession. We don’t believe in a credit crunch leading to a recession. Equity markets should therefore rise slightly, up around 10% on a 12-month view. Government and credit risk premiums will narrow over the year and core nominal rates, meaning Germany and to a lesser extent France, should improve moderately as the uncertainty premium diminishes. We should see a lot of volatility in early 2012, after which things will get better.

EBM: What is your view of current equity market valuations compared with historical levels?

Philippe-Henri Burlisson: One should always be wary of historical comparisons. If you consider the euro zone going back to 1999, P/E levels drop from 25 to 10, and you think “super”. But if the graph is drawn from 1970, P/E levels of 10, which is where we are now, appear not to be so unusual. So one shouldn’t put too much emphasis on this type of argument. Taking another example, the DDM, i.e. the implied growth of dividends needed in the market to explain current prices for the next 10 years, implied growth rates are all but negative. It is easy to see that the markets have fallen too far in valuation terms. Which is rather good: prices won’t fall further but they’re unlikely to rise sharply either. On the other hand, not priced into the market at the moment are assumptions concerning earnings per share. When it comes to a comparison between 2012 and 2011, analysts still expect rises of 8%, 10%, while we rather expect a decline of 9%. So a few surprises can be expected regarding corporate earnings, but current valuations should make it possible to avoid falls and justify a slight rise.

EBM: Why do you currently favour the credit asset class?

Philippe-Henri Burlisson: Credit is supported by three main factors. First, credit companies have substantially improved, cleaned up and deleveraged their balance sheets. We are now at levels where a fairly moderate default rate can be anticipated. This is good news. Second, their refinancing needs are about to ease, mainly thanks to the ECB. This is uncommon, which is good news for this asset class. Third, it offers a return – a fairly good one when you look at risk premiums – that is attractive for long-term institutional investors. Moreover, there is downward potential for the risk premium, so that’s positive for credit. But one has to be careful, very selective – credit is not being bought in large quantities. Investing in senior bank debt is clearly not the same as investing in subordinated debt.