After the near-capitulation selling we saw at the end of 2018, January saw confidence returning and equity markets staging a comeback.

Most of the attention was directed towards the US Federal Reserve and the ECB. The Fed meeting was extremely dovish in tone and intent and stocks rallied in response. Some of the momentum that had propelled European equity markets higher in January carried over into February.

Yet, as the reporting season progressed, we noticed a steady drip of downgrades to earnings forecasts. This is something we will be mindful of over the months ahead.

The big news in March was the capitulation of the US Federal Reserve. With expectations of higher interest rates having been all but abandoned, thoughts immediately turned to the prospect that rates might need to be cut…

Combined with the Feds promise to stop shrinking its balance sheet later this year, the hope trade once again boosted asset prices.

TheArtemis Funds (Lux) Pan-European Absolute Returnfund made a positive return over the quarter. By sector, energy was the best performing area of the market for us over the quarter. Saipem responded belatedly but strongly to a raft of new contract wins. CGG, Technip, Subsea 7 and Premier Oil also performed well. While the rise in the oil price undoubtedly helped, we are also encouraged by the fundamental improvement in activity levels across the services sector despite recent volatility in commodity prices. Royal Dutch Shell confirmed the dilemma being faced by the industry: its results showed reserves are being depleted far more quickly than they are being replaced.

Source: Lipper Limited, data from 31 December 2018 to 29 March 2019, mid to mid. All figures show total returns with dividends reinvested. Benchmark is LIBOR 3 months.

Elsewhere, Mediaset Espaa announced it would buy-back 10% of its outstanding shares and also reported a gain in audience share. This is something to think about for those that believe free-to-air television has no future in the Netflix world.

The fund also did well in financials, with positive returns from Amundi, Amina and Cembra. The latter is an excellent example of a company sticking to what it does well and not straying beyond the bounds of its competence.

In such a buoyant market, a large chunk of our losses inevitably came from the short book. Detractors were from a range of sectors, but predominantly consumer discretionary.

Most of our recent ideas have been additions to the short book and we must trust our analysis to tell us what that means for the bigger picture. The world of investing is constantly generating new themes. Often, these are simply old themes dressed up in different clothes.

One recent fashion has been the concept of zero-based budgeting. This advocates setting each years spending plans at zero and only spending what is strictly necessary. Inevitably, margins look great at first. The danger is that it eventually starves a business of necessary investment. We are beginning to see the negative impact of this on some consumer goods companies: fail to remind your customers why they should buy your product and some will eventually look elsewhere. Recovering those lost customers means ramping up spending and thereby produces a profit warning. This is a process we are trying to take advantage of in our short book. Many of the companies we see at most at risk are trading on pretty high valuations.

At the end of the quarter, our net long position was as low as it had been in years.

Our main worry is that when share prices go up but expectations for earnings are revised down, stocks simply become more expensive. There is something of a logic gap in opting to pay more for companies whose prospects are deteriorating. It is not the normal behaviour associated with investors in equity markets.

The only time it has made sense historically is at the end of the earnings-downgrade cycle. But today we are at the beginning of that cycle. Hence the risk is that optimism fades rapidly once faced with the reality of bad news. We are positioning the portfolio in expectation of this outcome.

Artemis Funds (Lux) Pan-European Absolute Return

Paul has managed the Artemis Pan-European Absolute Return Fund since launch in July 2014 and Artemis Funds (Lux) Pan-European Absolute Return since launch in August 2018.

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