The companies that led European markets this year are not going to be the ‘winners’ of 2021, according to investment experts.
The value and cyclical names that took a beating during the coronavirus pandemic look set to benefit from the recovery in European markets, while the previously outperforming growth names are tipped struggle to maintain their stretched valuations.
European markets took a significant hit during the Covid-19 pandemic as repeated lockdowns put economies and markets in a ‘stop-start’ pattern.
European indices YTD
Source: FE Analytics
But James Rutherford, head of European equities at Federated Hermes, is expecting that the return to more ‘normal’ financial and economic conditions will bring about a recovery and consequentially a rotation in markets leadership.
“As we look ahead in to 2021 there is some hope of a return to normality, to mobility and economic activity, which should see the emergence of a strong earnings recovery in the more economically sensitive areas,” Rutherford said.
“This is a significant portion of the European market and an area that has been effectively held hostage by the pandemic, causing companies to set a low base from which to grow.
“As such, we expect to see some mean reversion of the fundamental performance of companies deemed to be the ‘Covid losers’, resulting in a broadening of market breadth, which has been very poor throughout 2020.”
Rutherford expanded that some of the growth names which have performed well in 2020 have now reached “lofty valuations”.
“In a market where earnings have been scarce this is understandable, but in some cases valuation metrics have been constantly adjusted to justify ownership,” he said.
“As the earnings scarcity diminishes, it could make some of these high multiple names vulnerable and provide opportunities in those names that suffered the most.”
This view is shared by James Sym, manager of the newly launched R&M ES River & Mercantile European fund.
He said: “Our contention now is that we are in the recovery phase of the cycle, which leads to an important investment conclusion.
“The likely winners over the next 12 months as the economy recovers and society reopens are very unlikely to be those that have benefitted from the conditions of 2020 so far.”
Because of this he said he is favouring an overweight in more cyclical areas such as consumer stocks, industrials and financials.
But one of the key challenges will be deciding how much capital to allocate to these “very beaten up, but very high operational and financial risk areas of the market”.
Sym said there is plenty relative upside in the slightly better ‘recovery stocks’, but some of these chancier assets could also prove to be “very profitable investments as they are rehabilitated”.
Another area the manager finds attractive is “cheap domestic exposure”, after seeing the cohesive and positive response by the European Union (EU) to the pandemic.
To try and help its members deal with the financial and economic impacts of Covid-19, the EU launched a record amount of stimulus.
The ‘NextGenerationEU’, more commonly known as the Coronavirus Recovery Fund, provided €1.8trn in fiscal stimulus.
The EU said this is a long-term budget to “increase flexibility mechanisms to guarantee it has the capacity to address unforeseen needs”. “It is a budget fit not only for today's realities but also for tomorrow's uncertainties,” the bloc explained.
One of the themes this fiscal stimulus is likely to benefit is sustainability.
One of the stipulations to the recovery package was that funds had to be channelled through the pre-existing European Green Deal, meaning the EU’s recovery from Covid-19 has been built around a goal to tackle climate change.
The EU’s drive for more climate friendly practices is set to enter investment markets next year, with its Sustainable Finance Disclosure Regulation (SFDR) coming into effect next March.
The regulation will enforce new ESG (environmental, social and governance) disclosure requirements on both investment products and managers in an effort to create distinction between investment vehicles which full integrate sustainability into the strategies and those that don’t.
With the EU’s recovery centred around climate change, Premier Miton Investors’ David Jane said the renewable energy sector could benefit.
“This sector is set to benefit from further government support post the US election and in Europe as part of the recovery package,” he said. “Its growth might even accelerate.”
Another theme which Jane said could benefit in the recovery is robotics.
“This is especially the case given the ongoing decoupling from China and businesses preference for automation post-Covid,” the multi-asset manager explained.
“That sectoral mean reversion is likely to lead to a degree of regional rotation as regions where these areas are heavily represented, particularly the UK, Europe and Japan accelerate against the tech heavy US market. Less certain is the potential for emerging markets to catch up.”
Looking ahead at European markets next year, Federated Hermes’ Rutherford concluded: “With the US election and Brexit hopefully behind us and with expectations of improved testing, treatments or even an effective vaccine reducing the impact of the virus going forward, the market will hopefully be able to focus on earnings.
“Moreover, stimulus and monetary policy is likely to remain accommodative for a very long time and, given the heavy weight of more economically sensitive stocks in Europe, the fundamental backdrop and relatively low valuations will remain supportive for a much improved market than 2020.”