You can easily understand why investor attitudes are very much leaning towards the glass is half empty view at the moment. Everything is bleak – be it inflation, interest rates or geopolitical concerns.
Europe, once again, is in the eye of the storm – to the point where many of us have almost become numb to the negative headlines which have become the norm for this part of the world.
When has Europe ever been a good place to invest?
I distinctly remember a call I had with a fund manager earlier this year – it summed up European equities perfectly for the past 15 years. He said: “When has Europe ever been a good place to invest as a whole? There is always something to worry about in terms of dysfunction from either an economic or political perspective. That is what gives active investors in Europe the opportunity to find great, globally exposed companies at attractive valuations – because of the stigma around Europe as an investment arena.”
It does hold true and is a timely reminder that the biggest gains are made by the investor who takes a step forward when everyone else takes a step back. You have to put that into context given that Europe is likely to head into a recession sooner than the rest of world.
Figures from the International Monetary Fund forecast advanced economies in Europe will grow by just 0.6% next year – it also adds that more than half of the countries in the euro area will experience technical recessions. Output and income are also expected to be nearly €500bn lower in 2023, compared to the pre-war forecasts.
“If Europe wasn’t hated in the investment world before, it certainly is now. After six months of war in Ukraine with no signs of ceasefire, a pending recession, and a deepening energy crisis, the sentiment is understandable.” That’s the view of Janus Henderson European Selected Opportunities manager John Bennett.
But while there is doom and gloom, Bennett also sees opportunity when it comes to energy prices, citing the large disparity between the fundamentals of many oil majors and their valuations (oil remains one of the best-performing sectors since the start of the year).
He adds that oil prices are likely to remain high given the lack of oil from Russia; a reduction in production; decades long underinvestment in the sector; and the view that demand will not fall to the degree many feel it could, should Europe enter recession.
While Bennett acknowledges the rest of 2022 will be volatile, opportunities will present themselves to add to existing/new positions due to potential valuations and fundamentals disconnects.
I’ve used this as an example – but it can be extrapolated across Europe – sentiment has created that same fundamental disconnect. Europe is home to a number of great companies with global revenues and is a market leader in numerous sectors like renewables, healthcare, and luxury goods. Many of these companies would’ve also fallen victim to poor sentiment.
Forgotten fundamentals and getting in while the going is bad
A recent article from Jupiter European manager Mark Nichols highlights the fact that consumer confidence in the region is now at its lowest level since records began in 1985 – adding that the market has historically performed following a bottoming of consumer confidence. At each of the previous turning points in confidence the market has delivered strong double-digit returns over the subsequent 12-month period.
Nichols also points to a valuation opportunity with forward price-to-earnings (P/E) ratios for European equities now sitting at levels last seen during the eurozone crisis more than a decade ago, while European equities are also trading at a significant discount to US equities.
On a forward P/E basis the US market (S&P 500) is trading at a 44% premium to the European market (STOXX Europe) – it has averaged at less than half that (19%) since 1995.
Amid this backdrop, figures from the Euro Area Business Cycle Network show there have been five recessions in Europe in the past 50 years – in four of these the MSCI Europe Index bottomed either in the quarter the recession began or the following quarter. This includes periods of stagflation in the 1970s and early 1980s, the downturn in the early 1990s, and the 2020 pandemic.
Lazard says the market is quick to de-rate European company valuations should we see a weaker outlook for the economy and company fundamentals. However, investors have also been quick to price in a recovery into the equity market.
It says: “It has done so with the economy still in a recession and as company earnings continue to fall, with merely initial indications of a recovery on the horizon. As such, waiting for company earnings to bottom to confirm a recovery has often meant missing a substantial part of the rebound in European stocks”
With this in mind, Europe is perhaps looking a far more attractive and fertile hunting ground for active managers than the headlines suggest. In addition to experienced stock pickers like John Bennett and Mark Nichols, I’d look to the likes of IFSL Marlborough European Special Situations fund and the GAM Star Continental European Equity fund, managed by David Walton and Niall Gallagher respectively. All have proven track records to tap into these valuations anomalies to find strong companies which have struggled strictly due to market sentiment.
Darius McDermott is managing director of Chelsea Financial Services & FundCalibre. The views expressed above should not be taken as investment advice.