There is still value left in European and Japanese equities despite their almost universal popularity with fund managers, according to a panel of financial experts.
A huge amount of bullish sentiment surrounds both Japan and Europe, with the two regions being frequently highlighted by professional investors as rare pockets of value with the potential for significant gains.
One obvious common denominator that both markets share is the continuation of aggressive quantitative easing programmes, which have been used to kick start the economies following prolonged periods of weakness.
Since the start of the year, the MSCI Europe ex UK and Nikkei 225 indices have outperformed the FTSE All Share, MSCI Emerging Markets and S&P 500 and are currently up 8.67 per cent and 12.28 per cent respectively.
Performance of indices since start of the year
Source: FE Analytics
However, alarm bells should always ring when a region or asset class appears to be flavour of the month with the majority. In light of this, is it prudent to turn away from European and Japanese equities and instead focus on more unpopular areas of the market?
Justin Onuekwusi, multi-asset fund manager at Legal & General Investment Management, believes that this is not the case and has recently reduced his exposure to US equities to increase weightings in Europe and Japan.
“Valuations are looking less attractive for US equities so we’re looking to phase in a decrease to US equities over time and increase our weightings in Europe and Japan,” he said.
“Why Europe? There are three things. Firstly, it’s the fall in oil price. That benefits Europe more than the US. Everyone focuses on gross consumption of oil, but we think the biggest focus should be on net consumption of oil.”
“Although the US is a big gross consumer, the oil industry in the US does contribute to US growth, therefore the fall in oil price impacts US growth as a negative as well as a positive. When you look at this, the biggest beneficiaries of the fall in oil price are Japan and Europe.”
Another reason that Onuekwusi is bullish on Europe in particular is the fall in the euro, which benefits European exporters. Of course, he adds that quantitative easing has also pushed bond yields down and has made other asset classes look attractive.
“We know one of the gains of quantitative easing is to create asset reflation. Therefore we think all three of those things together mean that European equities look attractive,” he added.
“You’re already seeing that coming through in some of the earnings numbers, but it may be that you don’t see the full benefit until the fourth quarter this year. We have to phase in that allocation over time.”
In contrast to Europe and Japan, US equities have had a strong run since the post-crisis lows, with sectors such as biotech proving to be immensely popular among international investors and the S&P 500’s outperformance over the MSCI World index.
Recently, however, the US index has dropped below the MSCI World, underperforming over six months by 1.88 percentage points and over three months by 1.21 percentage points.
Performance of indices over 6months
Source: FE Analytics
Psigma chief investment officer Tom Becket still favours Japan and Europe over any other global developed market as he says they offer much better potential medium-term value than the US, which is starting to play out quite strongly.
“I think there are good reasons why that can continue. Broadly, we think that most investors are still talking the talk rather than walking the walk when it comes to European and Japanese equities, and there is still considerable amounts of further buying that can take place,” he reasoned.
“In simple terms, borrowing costs are low, companies are focusing much more on their necessary operations rather than employing useless people, they’re starting to focus more on their balance sheets, they’re starting to pay higher dividends and the cheaper costs and improving sales should lead to decent profitability.”
“My view is that Japanese and European equities’ outperformance that we’ve seen so far this year might well stall short term, but we think that investors can achieve their longer-term growth ambitions rather here than with a US market, which still looks expensive to us and primed for disappointment if you are to see no furtherance from corporate profits.”
While Japan and Europe’s popularity has not deterred many investors, some are watching the markets closely to gauge whether they are becoming saturated.
Simon Evan-Cook, a manager on Premier’s multi-asset funds, likes European and Japanese equities and has been bearish on the US for a while. However, he is concerned that so many investors share the same sentiment.
“We would not disagree with the view that it’s a good way to be positioned, but we are wary that people are starting to position that way so we are talking a little bit more about reducing the positions that we have, although we haven’t done a great deal on that yet,” he said.
The fund manager also believes that the hype surrounding Europe and Japan has overshadowed stellar opportunities in other markets, such as the emerging markets sector.
“It seems to be the part of the market that nobody wants to touch, but to us it look very interesting, particularly in areas such as Latin America where you’ve had really poor sentiment surrounding certain parts of the economy. Perhaps correctly, because those economies haven’t been performing very well, but there are signs that tides are beginning to turn a little bit,” he explained.
“Companies’ earnings are being downgraded much less quickly than they have been in the past. I think that’s something that people don’t seem to be talking about.”
Bestinvest’s Jason Hollands agrees that buying into the regions has almost become consensus trading, but he has moved quite heavily into both markets over the last couple of years.
He says that the macroeconomic tailwinds in both countries are so strong that the regions are still offer good investment opportunities, despite their popularity.
What’s more, he says that, even if valuations in Japan and Europe increase, it’s very difficult to find compelling value in any asset class at the moment.
“I think we’ve had years of asset price inflation as a result of the misallocation of capital through mass central bank stimulus programmes,” he said.
“Bond markets clearly look abnormally expensive but that’s then had a knock-on effect on the equity market so it’s very difficult to see anything in mainstream classes where, hand on heart, one would say it’s a bargain.”
