The European economy is undoubtedly starting to show cracks in the face of the Ukraine crisis. In Germany, the government’s council of economic advisers has halved its projections for economic growth, with one council member saying that the risk of recession was “substantial”. European Central Bank President Christine Lagarde has also warned on how a prolonged conflict could damage European growth.
This is certainly a concern for European companies. We have been looking hard at the companies in our portfolio to try and understand how they could be affected by rising energy costs and any knock-on effect on consumer demand. However, we believe it is also worth noting that the strength in the Eurozone economy has never been a prerequisite for the right companies to make progress.
As it stands, we are perhaps less pessimistic about the region’s economic prospects than some of the more bearish analysis suggests. Certainly, the crisis in Ukraine will be a dent to growth, but the region was coming from a relatively strong position of mounting recovery.
Equally, corporate earnings have so far held up relatively well despite the challenging environment. However, it is not necessary to be bullish on the region’s prospects to find investment opportunities within it.
Operational vs share price performance
Through 2021 and in the current crisis it has been vitally important to distinguish between the operational performance of companies and their share price performance. While share prices have been volatile, the companies we hold have delivered well on their strategies. Last year was a formidable test for management teams, but they have rewarded our confidence.
If operational performance improves at the same time as share prices are falling, it may also present an opportunity for active investors. The capital has exited from European funds over the past few months on fears of contagion surrounding the Ukraine crisis. Higher quality companies with earnings relatively unaffected by a weakening economic picture have been sold down alongside more vulnerable companies.
Nevertheless, we do not ignore the economic implications of the crisis. In particular, the Ukrainian conflict is likely to push inflation higher, as energy and agricultural prices rise. We are also seeing rising costs in the steel sector because Russia and Ukraine are exporters of steel.
We had thought that inflationary pressures would start to ease in the second half of this year and this makes the direction of inflation more uncertain.
Pricing and procurement power
There are ways to deal with this in a portfolio. For example, it is even more important to find companies with pricing power. We want to ensure our portfolio holdings can pass on input costs to customers and negotiate effectively with suppliers. Scale in procurement means a company will be a priority customer for suppliers. Their supply chains are not as vulnerable to disruption. This should give a clear competitive advantage.
While a buoyant economic climate floats all boats, a more difficult climate requires greater selectivity. Those companies that are depending on growing consumer spending, for example, are likely to be vulnerable in this situation. We look to back business that should be resilient in the face of economic uncertainty with growing end markets that are relatively insensitive to the economic climate.
Growing markets
This leads us to specific areas, such as digitisation or electronic vehicles. The crisis may accelerate progression to net zero, both as a result of greater urgency from policymakers, but also as consumers speed up adoption of electric vehicles.
Equally, there is a long-term structural increase in demand in sectors such as semiconductors, which should endure whatever the economic weather.
In unstable times, we see real danger in aligning a portfolio with growth or value, or to the outcome of a macroeconomic event.
On the BlackRock Greater Europe IT, we look to focus on what we can know and understand – companies with strong fundamentals. The economic environment may be challenging, but great European companies can thrive even in difficult conditions.
Stefan Gries is co-manager of the BlackRock Greater Europe IT. The views expressed above should not be taken as investment advice.