Having been the perennial source of bad news for global economy, sentiment towards Europe has picked up significantly over the last 18 months or so.
Performance of indices over 1yr
Source: FE Analytics
While the MSCI Europe ex UK has delivered a 14 per cent return over the last year, it has been the heavily indebted peripheral markets such as Italy, Greece and Spain which have rallied strongly on the back of extremely low valuations.
De Fonclare (pictured), who manages the £869m Jupiter European Special Situations fund, says that the outlook for Europe is certainly looking more positive but he warns about over-optimism in the lower quality areas of the market. “The market is being driven by momentum and sentiment,” de Fonclare said. “The backdrop is improving and the movement in peripheral bond yields as helped because it has lowered the cost of debt.”
“However, as we all know, markets can shift from extreme negativity to excessive optimism very quickly.”
“Analysts are having to upgrade their numbers each month which makes me slightly nervous, because current forecasts are factoring a very quick economic recovery.”
“Yes, there is a recovery, but consumers, who have been hit very hard by the crisis, aren’t just going to start spending again straight away.”
He added: “I think people need to be more realistic. A lot of the positives are now already priced in. That is the risk.”
The manager understands why investors having been buying areas such as Greek and Spanish domestic banks because of previously extremely low valuations, but warns they are the type of stocks that could gain 10 per cent in day, but then could quite easily lose you 15 per cent the next.
Nevertheless, a number of De Fonclare’s peers have been upping their exposure to peripheral and Southern Europe recently.
FE Alpha Manager Barry Norris, for instance, has bought Greek equities, most specifically its banking sector, for the first time since 2006 for his FP Argonaut European Alpha fund to play the so-called “Grecovery”.
De Fonclare says that the rally has been largely driven by foreign capital, but says those investors will have little problem with repatriating that money if the outlook becomes more uncertain.
He also points to the differentiation in performance between Italian equities against their German counterparts so far in 2014 as a way to show just how far sentiment has gone.
Performance of indices in 2014
Source: FE Analytics
Given how far the wider European market has come recently, he warns that investors who are trying to benefit from the peripheral recovery now may have missed the boat.
“I can’t see how European equities can make any more significant headway without top-line growth. The exercises of cost-cutting have largely been done and the real re-rating happened last year, which means that valuations are back in line with historical averages.”
“We need top-line growth, which will then turn into better earnings growth.”
De Fonclare says the major caveat to that is that the ECB might implement QE to stave of deflation and the added liquidity would benefit the equity market. However, he says it is difficult to predict when or how they would create that stimulus.
De Fonclare has managed his Jupiter Special Situations fund since July 2005.
According to FE Analytics, over that time it has been a top quartile performer in the IMA Europe ex UK sector with returns of 118.13 per cent and has beaten its benchmark – the FTSE World Europe ex UK index – by more than 25 percentage points.
Performance of fund vs sector and index since July 2005
Source: FE Analytics
It has also outperformed over rolling three and five year periods, however it has underperformed over the last 12 months and the manager attributes those relative poor returns to his focus on quality companies.
However, while de Fonclare is concerned about over-optimism in the market, due to recent company management meetings and pick up in PMIs, he is still relatively bullish on the region as a whole.
He has been reducing his weighting to some of his long-standing structural growth names that can grow their earnings no-matter how the economy is performing as he wants his portfolio to have a more cyclical tilt.
“Structural growth has been the place to invest over recent years on the back of political and economic uncertainty. Those areas have done very well for us, but we are now taking profits and targeting cyclical growth companies,” de Fonclare explained.
For instance, the manager has been upping his weighting to more economically-sensitive sectors such as media and technology as he expects a pick-up in capital expenditure.
He has also been increasing his exposure to financials such as banks, topping up his holdings in UBS, BNP and ING recently.
The Jupiter European Special Situations fund’s clean share class has an ongoing charges figure (OCF) of 1.04 per cent.
