While the MSCI Europe ex UK index is only down 0.8 per cent year to date, there have been some huge falls over the last 12 months and the large majority of investors have seemingly given up on European equities going into 2015.
Performance of index in 2014
Source: FE Analytics
Concerns of a Japanese-style deflation spiral, the rise of nationalistic political parties and the issue of whether the much talked about sovereign QE in the eurozone is actually legal have all spooked investors and led certain experts to describe the continent as an “almighty mess”.
However, FE Alpha Manager Rob Burnett – manager of the £600m Neptune European Opportunities fund – says all these concerns about potential headwinds mean European equities are one of the most fertile hunting grounds for contrarian investors next year.
“A lot of people look at sentiment and they consider surveys and they speak to clients but I like to look at fund flows,” Burnett (pictured) said.
“What is exceptionally interesting is that we saw the biggest outflow in European equities ever in September/October, bigger even than what we saw in the maximum period of pain during the financial crisis in 2007/2008.”
“It is interesting because it shows that sentiment is actually really weak and a lot of the fast money has left Europe. From a contrarian perspective, it is good news that a lot of investors have given up on Europe because we know, time and again, they leave and then they return.”
Burnett has therefore maintained a very cyclical portfolio, with chunky positions in European banks and peripheral markets such as Italy as he thinks now is a perfect buying opportunity for long-term investors.
“Europe is one of the cheapest places on planet earth right now. This is really nice to know because when you are thinking of allocating money into a market with a 10-year view, you know that if you have very cheap valuations, it massively increases the probability of good returns.”
“Sentiment is weak and valuations are extraordinarily low – that’s wonderful news in terms of the prospects for the equity market.”
However, it won’t come as much of a surprise that a European manager is talking up European equities and history has shown that just because an asset class is cheap, it doesn’t mean it won’t get even cheaper.
On top of that, it’s not as if Europe has been a difficult place to invest, given that the MSCI Europe ex UK index is already up roughly 50 per cent over three years.
Performance of indices over 3yrs
Source: FE Analytics
FE Alpha Manager David Coombs, head of multi-asset at Rathbones, is among a number of experts who have warned that European equities are cheap for a very good reason and therefore has very little exposure in his portfolios.
“We acknowledge that there will be times when being underweight might hurt us tactically, but that’s something we are willing to stomach for a region with pronounced recessionary and deflationary conditions,” Coombs told FE Trustnet earlier this month.
“In fact, investors are at risk of buying a value trap if they jump in on cheapness alone.”
Though many column inches have been dedicated to the prospect of recession in the eurozone following recent negative PMI statistics, Burnett says Neptune’s “Real Time Index”, which incorporates 40 to 80 data points for each country on a daily basis, shows that things have started to pick up in Europe over the last few weeks.
He also points out that deleveraging in the eurozone, which has been a major headwind for the equity market, is coming to an end as well.
Nevertheless, Goldman Sachs’ Andrew Wilson has warned FE Trustnet that the major problem for equity investors is that the European Central Bank (ECB) will struggle to stave of the threat of deflation.
“That threat of eurozone-wide deflation is real and it’s already happening in certain areas. It is a big threat and I think the concern for central banks around the world, but most pressingly for the ECB, is that when you get into that deflationary trap, it’s really hard to get out of it,” Wilson said.
David Jane, manager of the CF Miton Special Situations Portfolio, is in a similar camp to Wilson as though he expects further stimulus from the ECB over the coming year, he questions how much of an impact will have in rescuing the economy.
“In the short to medium term, the key to the eurozone real economy is global end demand and, in the absence of a pick-up, prospects look fairly grim,” Jane (pictured) said.
“Sure, an announcement of public QE would likely see the euro and bond yields trend lower and this would some be some stimulus to the economy, but how far can they go from here?”
Inflation in the eurozone has fallen to 0.3 per cent but Burnett says investors are underplaying the huge amount of ECB support which is on its way. He says that not only will it help generate inflation, but it will significantly boost equity markets.
“Over the last 100 years, there has been a really good rule of thumb and that is ‘don’t fight the Fed’,” he said.
“And yet, today, European investors want to fight the ECB as it wants to lift the equity market and the economy, but investors are saying ‘I’m not supporting it and I don’t believe in it’. But, there is a hell of a lot of supportive programmes and there is a real alphabet soup.”
“We’ve got the TLTRO, the ABS programme, the covered bond programme, they are probably going to buy corporate bonds and there is probably sovereign QE coming quite soon. Bottom line, they want to lift their balance sheet by €1trn.”
He added: “That is very, very constructive for the equity market going into 2015 and 2016.”
Burnett has managed his Neptune Opportunities fund since May 2005.
According to FE Analytics, it has been a top quartile performer in the IMA Europe ex UK sector over that time with returns of 139.87 per cent, beating its MSCI Europe ex UK benchmark by close to 50 percentage points.
Performance of fund vs sector and index since May 2005
Source: FE Analytics
However, the fund has fallen into the bottom quartile over one, three and five years as Burnett has struggled relative to the sector and his benchmark since 2011. For example, it has been the fourth worst performer this year with losses of more than 8 per cent.
It is a concentrated portfolio of around 40 to 60 holdings and is likely to perform well if sentiment towards Europe changes. He has very large overweights in the likes of Italy, Spain and Greece and counts three peripheral banks in his top 10 – CaixaBank, Intesa Sanpaolo and Banca Popolare Di Milano.
Neptune European Opportunities has an ongoing charges figure of 0.82 per cent.
