Though European funds rallied in 2013 on the back of bullish rhetoric from the European Central Bank (ECB) and a more general ‘risk-on’ environment in global markets, 2014 proved to be a much more difficult environment for managers in the sector as fears grew about deflation and weak economic growth in the eurozone.
In fact, according to FE Analytics, the IA Europe ex UK sector was the worst performing mainstream equity sector last year as the average fund lost 0.94 per cent. As a point of comparison, UK, North American, Japanese and global emerging market equities all made positive returns.
Performance of sectors in 2014
Source: FE Analytics
Given that inflation in the eurozone officially moved into negative territory in December and worries still persist about not only the effectiveness but the legality of the ECB’s anticipated quantitative easing programme, a number of experts have been shying away from the continent within their portfolios.
However Gregory, head of global equities at the firm, is far more bullish and thinks now is a very good buying opportunity.
“We think in Europe, which everyone loathes, things are actually improving,” Gregory (pictured) said.
Though he thinks QE in Europe will happen and will have the desired effect of bringing about growth and producing inflation, he says corporate profitability is already showing signs of improvement.
He points to the fact that over the past couple of weeks, more cyclical companies such as Continental – the German automotive manufacturing company – and Metro – the media company – have both posted good updates to the market, despite the supposed headwinds facing their industries in the current environment.
“We think that will continue and therefore European equities will do better this year against a tough backdrop. There are some indications that actually European earnings are finally climbing off the canvas,” Gregory explained.
“As ever, in May last year when everyone was optimistic about European equities, people had really outlandishly high expectations of around 20 per cent earnings growth which proved to be totally spurious. But, now people are much more bearish, the outlook is much better as companies, via self-help and via the fact the euro has been weak, are growing earnings which is going to be good for European equities.”
Gregory also says that not only are earnings turning a corner, but investors can find fantastic value in parts of Europe. He is specifically targeting the Italian equities, which are currently on a price to sales of below 0.6 and price to book of below 1.1.
There are a number of managers who are betting big on that peripheral market, following the MSCI Italy index’s loss of 4 per cent last year.
FE Alpha Manager Rob Burnett’s Neptune European Opportunities fund, at 33 per cent, has the highest weighting to Italian equities in the sector.
Burnett told FE Trustnet that he expected 2015 to be a very good year for Europe and his fund is far more cyclically focused than the majority of his peers, as his two largest sector weightings are financials and basic materials.
According to FE Analytics, the £580m Neptune fund has been a top quartile performer since Burnett took charge in May 2005 with returns of 135.68 per cent, and has beaten its MSCI Europe ex UK benchmark by 40 percentage points over that time.
Performance of fund vs sector and index since May 2005
Source: FE Analytics
FP Argonaut European Alpha, Franklin European Opportunities and Schroder European Alpha Income all have more than 10 per cent in Italy as well, according to FE data.
Gregory also says an attractive opportunity has opened up in Europe because so much money has poured out of the market recently, as September and October saw the biggest ever outflow from European equities, even more so than during the global financial crisis.
“The love affair with European equities has changed,” Gregory said.
“In the second quarter of last year, everybody thought things would be improving in Europe and everyone, particularly US managers, was long the market. Then literally everything collapsed towards Europe mainly because of fears about deflation, which have been somewhat founded though we expect the ECB to announce QE.”
The ECB has already introduced certain policies to inject liquidity into the market, such as announcing negative interest rates, buying up the asset backed mortgages (ABS) market and purchasing covered bonds from banks.
However, as the eurozone moved into deflation in December, many – like Gregory – expect the central bank to start purchasing sovereign debt after its meeting next week.
Some have questioned whether this will actually happen, given opposition from Germany and concerns about the legality of such a programme, but Gregory says it is now almost an inevitability.
“If they don’t [announce QE] all hell will let loose because it is clearly fully factored into markets,” Gregory said.
“This morning, the Luxembourg courts ruled that the OMT [outright monetary transactions] was legal and that really does pave the way for QE to take place next week if Mr Draghi can get it through.”
“His credibility is fully on the line now and so we fully expect there to be some form of QE programme next week – it’s just a matter of how big.”
“If Draghi learns any lesson from the Japanese, it will be to surprise markets on the upside because doing less than is expected will be very painful, he will have to do more. He realises that and he has been very good at that, in terms of giving out the impression that he is releasing a bazooka, so if he gets it through, there should be a decent rally in European equities.”
Bullish comments from the ECB have spurred on the market in the past. One of the best examples was in June 2012 when Draghi vowed to do “whatever it takes” to save the eurozone, which subsequently caused European equities to rally.
Performance of sector and index between Jan 2012 and Dec 2013
Source: FE Analytics
Though Gregory is bullish on Europe, he says investors need to be active this year and make sure they are ready to lock-in profits if the market rallies significantly over a short period of time.
“If there was a very strong rally in European equities and we got all of our return early in the year, I suspect we would move back to a more neutral stance pretty quickly,” he said.
“It is that sort of environment for markets. Whereas over the last five years it has always been right to buy stocks on weakness rather than always selling on strength, we now think we are in a flatter environment and it will be prudent to take profits in markets when you see them.”
“We will do that if European equities, as we expect, do rally strongly in the months ahead.”