Investors stand to receive the best returns from European and Asia ex Japan equity markets in the coming year, according to Nick Mustoe (pictured), chief investment officer of Invesco Perpetual, who adds fixed income is ripe for a correction that could last “several years.”
With 2015 drawing to close, it is increasingly clear developed market equities have been the place to be for investors this year, emerging market stocks the place to avoid and fixed income the place to see little in terms of return.
However, generally all asset classes and sector have been volatile, unpredictable and (in many cases for those that put their cash to work at certain times of the year) perilous.
According to FE Analytics, for those investing in funds within the Investment Association’s universe, Japan has dominated the tables with the IA Japan and IA Japanese Smaller Companies the first and second best out of the 38 sectors.
Source: FE Analytics
While Europe ex UK funds are not far behind, Mustoe - who aside from being the group’s chief investment officer also manages a range of portfolios including the Invesco Perpetual Managed Growth and Invesco Perpetual Managed Income funds - says Japan will make little short term progress next year while Europe’s besieged stocks will soar.
“European equities are my favourite equity market for 2016 with a lot of upside to come - there is a large catch up to happen. European equities offer the best combination of good valuations and decent upside because the European recovery will get gradually better and better,” he said.
“It has a lot of upside and low valuations. That is critical for us.”
Mustoe reasons that the mix of a weak euro, low price of oil and continued low interest rates combined with structural reforms across Europe such as in Spain and Italy as well as a lack of opportunity in other core markets such as the US will give a significant boost to European stocks.
“That is a pretty powerful cocktail for growth to be just a bit better than everyone is expecting. It is not saying we are going to have high growth but we just need it to be on an improving trend,” he said.
“Just look at how Spain has surprised everyone over the past couple of years and how well the Spanish economy has done despite having high unemployment. The benefit has come from structural reforms and a bit of momentum.”
“We think that is likely to happen in Italy, who have put through labour market reforms which you'd never think was possible in previous years”
Since the end of 2011 when European markets plunged as the continent’s sovereign debt crisis unfolded, funds have rallied off the back of strong policy commitments from the European Central Bank as well its quantitative easing programme announced this time last year.
Performance of sectors and index over 3yrs
Source: FE Analytics
However, there have been several stumbling periods with many retail investors cagey to buy funds specialising in this area.
However, many fund managers have been scooping up exposure with the Bank of America Merrill Lynch Global Fund Manager Surveys showing for much of 2015 that European equites have been increasingly popular.
The latest numbers from the survey show it is now the most popular overweight position among fund managers, alongside Japan.
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Our data shows nearly two-thirds [65 per cent] of the 267 funds in the IA Global sector are overweight Europe ex UK, with some 45 funds holding more than 15 per cent in the region. This includes the £1.3bn Invesco Perpetual Global Equity, which is headed by Mustoe.
He thinks that the market will become more and more popular, believing the past few years’ of reticence from retail investors will fall.
“It was a bit of mistrust, we’ve had two crises and whenever there is a synchronised global event you tend to find Europe stumbles but that will gradually dissipate because you can’t deny the growth we are seeing.”
“You can’t deny the results we seeing from companies. The last results season was pretty good. We are seeing earrings come through and we should get a decent level of earnings growth next year compared to other markets.”
The manager is adding to Europe as well as another the market that has been among the worst of this year by selling Japan.
“Previously I have had a decent weighting in Japan and liked it for a couple of years because of the potential for improved corporate returns. However, going into 2016 the bigger opportunity is Asia ex Japan. This is because valuations have got pretty low.”
“Most investors have focused on a slowing China which has created some of the market volatility that we have had for global equities overall. But that has meant that Asia generally is trading at a pretty low valuation in P/E terms. It is way down compared to its long term levels.”
“I’m gradually putting some money to work because it is trading at a discount to other markets. It will probably be the next thing post Europe.”
Performance of sector and index in 2015
Source: FE Analytics
Mustoe’s bullishness on Europe ex UK and Asia ex Japan stands in contrast to his concerns for the bond market which he is mostly avoiding, in anticipation of a correction looming in the near term.
“We're nervous about fixed income. I have virtually nothing in government bonds and a small weighting to corporate credit. That is reflecting a consistent view that fixed income markets in general have very little to go for in terms of real upside for a long term investor.”
“We are taking a prudent view to try and wait for the opportunity, which we think should develop at some point, when fixed income markets will correct. We have started to see that happen in high yield: that could be an early sign.”
“It is hard to say how much and for long it will correct. It could be over a number of months or even years.”
Performance of manager and peer group since 1 December 2010
Source: FE Analytics
Mustoe has a track record in our data going back to December 2010, since which he has beaten his peer group composite almost –four-fold.