FE Trustnet recently carries a warning from a number of highly regarded managers that the top-down picture remains worrying on the continent, despite its recent share price gains.
Performance of indices over 2yrs
Source: FE Analytics
However, Taylor (pictured) and Stephanie Butcher, manager of the Invesco Perpetual European Equity Income fund, say that investors’ major fears for the continent aren’t justified.
Here they outline why the key concerns investors have about Europe are misguided. 1. Deflation is not a threat
Most of the fears around Europe centre around the spectre of deflation haunting the continent.
Deflation is where the earning power of money increases with time, meaning that prices fall. It is feared because it is viewed as creating a dynamic that destroys economic growth: consumers avoid spending in the belief that prices will fall reducing the economic activity in the economy.
So feared is this spiral that governments target mild levels of inflation – 2 per cent in the UK – to be sure of avoiding it.
With eurozone inflation falling to 0.5 per cent in March, its lowest since November 2009, there are real fears that Europe could enter down this path that was so destructive for Japan for many years.
However, Taylor says that he does not think deflation is a real threat. As much as 70 per cent of the headline decline in inflation is attributable to falling energy prices and food prices, he says, which are not typically signs of troubling deflationary trends, and in the case of energy prices can actually help an economy.
2. The domestic revival in confidence is springing up
Butcher says that there is a lot of evidence of an increase in business confidence even in the peripheral areas of Europe.
“Economists’ forecasts change rapidly, and we prefer to look at bottom up things, some of which can be quite small,” she said.
She explains that one sign of growing confidence in Spain is the pick-up in white van registrations in the country.
“If you think of who is registering those white vans it gives you a good example of building confidence coming through in one of the countries most hit by the crisis,” she said.
Butcher (pictured) also warns against taking dire warnings about the levels of youth unemployment in peripheral Europe seriously. While headline figures in Spain may reach 50 per cent these numbers include young people in university and other education, therefore are significantly overstated.
The real number is closer to 25 per cent, she says, which while still very high is much lower than many of the figures bandied about.
Taylor adds that there is an uptick in corporate investment underway as companies are reaching the point where it could be more expensive for them not to invest rather than to invest.
“You are starting to see a pick-up in capex in some areas,” he said.
3. The eurozone crisis is over
“You have to preface everything with “never say never”, but we have an awful long way,” Taylor said. “The idea of a systemic collapse is a long way away from where we are now.”
Taylor says that there has been a great deal of structural reforms, even in the periphery, and Butcher highlights labour market reform in particular.
“There’s an element of reverse engineering [of institutions] going on,” Taylor admits.
However, he highlights that Invesco Perpetual’s house view was always that there was not going to be a split in the eurozone.
“We have never believed in a collapse in the eurozone and that has been one of the major themes in our portfolios over the last few years.”
Butcher says that the managers met with many officials and politicians during the crisis and took away a firm conviction in the latter’s determination to make the project work.
4. A strong euro is not a threat
Taylor says that one of the headwinds for the continent has been a strong currency, but this is likely to change over the next year or so.
“It’s not helpful,” he said. “The euro has been stronger than people expected, but is it driven by eurozone factors or those from elsewhere?”
“We would expect the dollar to strengthen over time, particularly because of interest rate rises and that differential will favour the dollar over the euro.”
A strong currency is not something the team is worried about, they say.
5. Earnings surprises are in store
Butcher says that Europe is going through the “growth” stage of an economic cycle, having passed through “panic” and “hope” stages.
This means that investors are going to increasingly focus on earnings improvements, and Europe is in a good place to deliver them given the deep recession it has been through.
“Where we are the market tends to be driven by earnings, we are not expecting massive movements in P/Es,” she said.
“But we are around 33 per cent off peak earnings, therefore is you are looking for companies with earnings revisions to the upside the starting point when you have already dropped 33 per cent is better than if you are in the States.”
“Earnings growth should really start to accelerate,” Taylor added.
