GLG's Lagrange takes top-down view of Europe’s woes

Pierre Lagrange, co-founder of GLG and new chairman of Man Asia, was in town briefly last Friday en route to Singapore. He gave AsianInvestor an exclusive that touched on a number of topics (which will be covered more fully in a forthcoming edition of the magazine).

Here, we discuss his thoughts about Europe. The interview was carried out before last weekend’s conjecture that the European Financial Stability Facility may be quadrupled in size.

What are your impressions about the events in Europe?
One should really be focusing on risk management more than anything else. Think about how much you can lose if you are wrong, because the markets will penalise you. Think hard about what you own, and don’t forget that the return on the stocks is going to be massively correlated with macro factors. 

However, we have extracted quite good value this year by stock-picking in Europe despite the terrifying macro. Why? Well, we didn’t know what the macro outcome was going to be. It is very dangerous and very binary. Therefore we tried to isolate the macro risk as much as possible.

How do you do that? Go long a stock and short via a CDS?
No, we tend to stay simple. Nothing more than the stock-picking that we do for very positive reasons and then try to understand what the aggregation of all those stocks represent together in terms of risk. We then see if we can hedge that risk with futures, the market or a basket of stocks. Things like that.

Is it getting worse or better in Europe?
In a sense, the situation is better now than it was a year ago, because the market has taken control of the process. Six months ago, the market accepted the way of working of the European governments. They were always one step behind – in the sense that they couldn’t do much to repair the system, but they’d fix it if it broke. Now, kicking the can up the road in this way has worked in the past, because the cycle finally turned around and at last arrived to bail them out.

Anyway, there was more deterioration, and incorrect expectations about how a country like Greece was going to grow, and the impact on its revenue collection and its core deficit.

Now the market has taken control and forces the governments to do things they would never have done. It’s a dangerous path because you can break things along the way, but ultimately it will be a positive path in the eventual restructuring of Europe’s framework. Plus we’ll get a clear indication of what are the value of assets in the banking system.

What single event could turn markets around, say good news about growth from the US, a flat-out Greek default or a eurozone Eurobond?
It would be nice to have that positive growth surprise, but I don’t think it is going to come. So we have to rely on active decision making – which could come in a couple of ways. Firstly, taking the losses on Greece and having a real Greek valuation would be helpful, because if you have a position like that in your portfolio, unless you take the loss on it, you can’t move forward.

If Greece defaults, wouldn’t markets just turn to Portugal or Ireland and say ‘ok your turn’?
It depends how it's managed. You can’t deal with Greece, but still leave outstanding the uncertainty about Spain and Italy.

Let's just set aside the other two countries you mentioned. Over the summer, because of obscure communications in Italy and a couple of other events happening there, you now have a situation where Italy has become part of the problem. Before that, you could proceed with governmental ‘break and repair’, but once Italy went in to the repair zone, you can’t repair it because it's too big.

Greece being marked properly then will be one event, but it won’t help the funding of the French banks. There are other decisions needed, such as about how the governments are going to deal with this. It could be an unconditional guarantee of liquidity extensions by the ECB.

Also, we need something to ring-fence or protect some of the big banks’ funding. If that happens there will be a massive reaction as people see governments putting actions behind their words. Then finally we can move forwards.

And everything will be back to normal?
There will be other problems, but the cycle of negativity needs to be reversed. A lot of the people who are getting murdered in the stock market don’t have a solvency problem, they have a liquidity problem. That liquidity problem can be fixed, it’s a question of the will to fix it. It won’t be by Eurobonds. Even though that is a great idea, it is a long-term idea, requiring a lot of changes that need to be voted through. We need something to work in the short term.

If there is money printing, which sectors will benefit?
Financial stocks will be an obvious beneficiary, but it is more important to have companies that are linked to the financials. I still have issues with valuing financials properly; we don’t have a good feel for return on capital employed nor on the cost of capital. They are nearly dead in terms of stock prices, so there would be a massive relief rally.

We know that non-financial companies are in good shape, but sentiment is affecting people’s behaviour, and we’re seeing a beginning to their weakness. It is an artificial weakness in the sense of it being contagion from the financials. If they immunise the financials, there is money to be made there, but I am more interested in industrial cyclicals and stocks that have been somewhat contaminated by financials but still have a very good business and dirt-cheap valuation.

Also this may be an entry point for Asian stocks that have been priced in for negative growth. They have fallen as a lot of people were already out of Europe, in the USA because it looked safer and in Asian emerging markets for possible growth.

It's not a fundamental problem for Asia unless you have a big slowdown in demand here. Europe is likely in recession for the rest of the year, so the question is how much is that affecting the prosperity of emerging markets.