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QE has unleashed a massive wall of money which is now hitting European equity markets. The market action on some days is truly scary and I have to go back in my memory to 1999 and the early part of 2000 to remember such an experience...that uneasy feeling that we are on-board a runaway train and that the only possible outcome is a derailment. I stumbled the other day on a price chart which epitomises this. It is Christian Hansen, a company producing enzymes for consumer goods and in which I do not hold nor had held any position, so I can claim to be objective. The stock is up 70% since mid-November, and the price curve has turned into a vertical line (have a look for yourself, it is impressive). The stock is now trading on 40x, whereas the medium term EPS growth has been 10% pa (2011/15), which is admittedly not bad at all but not really mind-blowing either. I was intrigued because: 1) earnings expectations since last November are down 1%; 2) the company is not benefitting materially from the rise in the US Dollar, the drop in the oil price or the cyclical rebound in the Euro zone; 3) the stock was not particularly cheap when the re-rating started (it was trading on 23x 2015 expected EPS). I asked an analyst what was behind this meteoric rise. He was lost for words and could only mumble that the Danish stock market was up 28% year to date. So, that was his explanation: Christian Hansen is up because anything else is up also.

In such a context, it may seem that picking stocks is going to prove an impossible task. I would definitely not argue the valuation of specific stocks because nowadays it is a sure road to perdition. However, I believe that there will be massive discrepancies in terms of earnings performance this year in Europe. Firstly, the overall expected growth rate for corporate earnings for the next twelve months is 9.6%, which is below the level expected (wrongly so) by analysts at the start of 2012, 2013 and 2014 (it was then 13-14%), whereas the macroeconomic context is radically different (and much more positive). This is wrong intuitively, earnings growth has got to be higher. Secondly, companies are not evenly exposed to the main factors that are driving the changes (lower oil price, higher dollar, rebound in consumer spending especially in the periphery). If you are in temporary staffing, you will will feel right away the benefit of the improved macroeconomic environment, but not if you are in long capex cycle, especially if you are servicing the mining or the oil & gas industries. If you produce in Euros and sell in dollars (Ferragamo), it is party time, if you do the contrary (Adidas), it is going to be painful. You would rather sell to consumers in Europe, than in Brazil, Russia or Turkey at the moment. Whenever, I come up with an earnings forecast, I realize that current market expectations have failed to fully digest the impact of these factors. This is our opportunity in 2015.

How long will this all last? As long as the oil price stays low and the respective monetary policies across both sides of the Atlantic continue to fuel the divergence between their respective currencies, things will remain firmly on their current trajectories. What is a coherent level of prices for equities when bond yields are forced to turn negative? I do not know, I just know that it is higher every day. Barring a negative geopolitical event (the perennial "know unknown"), I think this whole runaway process can only be stopped by ending QE in Europe. QE has barely started, but I have already noticed an article in Handesblatt, the German financial newspaper, calling for an end already to it. Everyone seems to be assuming that QE will run its course until September 2016, and therefore, that the scenario for financial markets for the next 2 years has already been written, but what if they were mounting pressure within some parts of Europe to stop it earlier as the sheer dimensions of the bubble we are creating start frightening us. True, this is premature musing, but to believe that the script is already written for the next two years is probably a fatal mistake. I wonder what will be the drop in the share price of Christian Hansen then.

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Lionel Rayon

Lionel joined Schroders as part of the acquisition of Cazenove Capital in the summer of 2013, having been at Cazenove since 2005. He is a senior member of the pan-European equity team and manager of the Schroder ISF* European Alpha Absolute Return (circa $1 Billion AuM). He is also responsible for developing and maintaining a fundamental and valuation screen of European stocks. The screen forms the basis for generating ideas for potential further detailed investigation by the European team within the framework of their disciplined Business Cycle Approach. Lionel joined from Citigroup where he was a Director in the European Tech Research Team. Prior to Citigroup, Lionel had been with Schroders Securities, as a French specialist, Nomura Research Institute, as a metals & mining specialist, Enskilda and Chevreux de Virieu. Lionel graduated from Indiana University (MBA) and Institut d'Etudes Politiques de Paris (BSc economics & finance). He has 20 years of equity research experience.

Website: www.schroders.com

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