The European equity market is one of the last macroeconomic stories yet to play out, according to Schroders’ Marcus Brookes (pictured), who says geopolitical fears have kept the market area looking attractively valued. 
He also says Japanese equities look attractive and is therefore double-weighted relative to the benchmark, but warns that US equities are teetering on toppy valuations.
“Obviously we have Brexit and there are going to be all sorts of worries about that,” the manager said. “I think that’s one of the many reasons why Europe is struggling; the international investment community has not been willing to put their money in Europe, there’s always been a reason to go elsewhere.
“In most people’s cases, it’s been in the US equity market which looks incredibly rich in terms of valuation.”
“[Europe] is really one of the last stories that hasn’t played out as much as it should have done.”
While most major equity markets have performed well – particularly in sterling terms - over the last year, the MSCI Europe ex UK index is trailing behind with a 29.08 per cent return over 12 months. This is second only to the FTSE 100, which has reaped fewer benefits of the currency translation given the weakness of the pound, and has been given a wide berth by many foreign investors due to Brexit-related concerns.
Performance of indices over 12months
Source: FE Analytics
However, Brookes says Europe’s economic fundamentals remain attractive and believes markets have priced in too much risk. In a bid for safety, he warns that many investors have instead piled into the US equity market, which is renowned for its mega-cap, high-growth technology companies such as Facebook, Amazon, Netflix and Google or ‘FANG’ stocks.
He is therefore underweight US equities and, in his Schroder MM International fund, he has a 22.3 per cent in North American funds (he also has some exposure to US equities through his 29.3 per cent weighting in global equity funds). In contrast, his FTSE All-World ex UK benchmark has a 56.65 per cent US weighting.
“Our call is that the global economy is okay, the profit cycle seems to be okay. Even in the US they have had six quarters of negative earnings growth and even that’s turned a bit,” the manager pointed out.
“So, the fundamentals of the US market are actually looking a bit better than they were, it’s just a valuation call.
“And for us, it’s more about the US possibly going sideways or devaluing slightly while the economy is okay, allowing Japan, emerging markets, Europe and Asia to catch up on some of that valuation gap that has been put into the market over the last seven or eight years.”
Performance of indices over 8yrs
Source: FE Analytics
Brookes is therefore cautious on US equities because he fears too many investors are “hiding” in the highly-valued market at once, rather than because there will be a “dreadful misstep” in the country.
However, he says this balance is already starting to change as more investors are rebalancing their portfolios and instead opting for Japanese or European equities.
This phenomenon is not new. In an article published back in June 2015, FE Trustnet posed the question as to whether investors should be concerned about Japan and Europe’s surge in popularity.
The response was overwhelmingly defiant, with Psigma’s Tom Beckett arguing there are good reasons for these equity markets to continue to performing over the long term.
“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,” he said.
Brookes agrees with this view and says that, while the popularity of both markets should be monitored closely, there is still significantly less valuation risk than if he were to be overweight the US.
“When people are talking about value as we have been today, the value market is definitely not the US. I think Japan and Europe, for developed markets, do look cheap. I think Asia looks really good value as well,” he explained.
“You have to be selective. When people talk about being overweight Japan or Europe they’re talking about a 1 or 2 per cent overweight maybe, but we’re quite heavily overweight Japan; we’re double-weighted in Japan so we really do think that’s an area that will do well for us.”
While his view on Japan and Europe is more of a value approach to investing, some industry commentators warn against this, given the violent rotation out of quality growth was already aggressively bolstered last year by the election of Trump as US president.
In another article published last month, Canada Life’s Mike Willans told FE Trustnet he had increased his exposure to defensive stocks and that all the money from cyclical and value stocks has already been made.
“Very quickly, any stock to do with infrastructure spending or to do with growth lifted very quickly and, if you want a ship today, how long does it take to get delivered? The answer to that is probably eight to 10 years,” he pointed out.
“A bigger military yes, more infrastructure spending yes, but, will we actually see that in growth? I think we have to have a phase where there’s a bit more clarity and consideration in terms of what all those [Trump’s] policies mean.”
While he believes we are late in the cycle, however, Brookes says there is still further for value to run.
“It’s late cycle and, late cycle, you tend to see a little bit of inflation coming through, which allows the Fed to raise rates. It also allows value to outperform and value tend to do very well late in the cycle, so I think the idea that value can only outperform for six months and that’s it is probably only true if this cycle is coming to a jarring end,” the manager continued.
“I think these US rate rises that are coming through this year have been anticipated for two or three years which is why the dollar is so strong. For the dollar to continue to be strong, you have to think about which currencies need to be weak against it.
“We can construct a case, I think, with the yen just because there is a huge amount of accommodation going on. But actually Europe is picking up pretty neatly.
“I think the real tailwind is that everyone is still so bearish about Europe but, actually, when you look at the data it’s looking pretty good. It might actually be okay.”
Since October 2004 (after becoming deputy head of multi manager at Gartmore), Marcus Brookes has outperformed his peer group composite by 19.58 percentage points with an average return of 144.99 per cent.
Performance of fund vs sector and benchmark since October 2004
Source: FE Analytics
His largest fund, the £914m Schroder MM Diversity fund, has a clean ongoing charges figure of 1.27 percent and yields 0.47 per cent.