It has not been smooth sailing for those investing in Europe in the past decade. It’s a market that has been riddled with challenges, such as the sovereign debt crisis and, more recently, trade wars, Brexit and the rise of populism.
It’s been a decade where negative headlines have dominated - but could the start of a new one see a change in fortunes for the region?
The start of 2019 saw the outlook for Europe go from bad to worse, as disappointingly weak economic indicators kept rolling in. Italy was in recession, while Germany was flirting with the possibility of following, as vehicle emission tests – introduced following the Volkswagen scandal – and a fall in car sales in China acted as a drag on industrial output.
It was, therefore, a pleasant surprise to see the MSCI Europe return almost 20 per cent in the last calendar year, as the region showed resilience in the wake of uncertainty. However, uncertainty has dominated sentiment, with all three European equity sectors seeing net outflows totalling almost £4bn between January and November 2019, according to figures from the Investment Association. Europe also saw net equity outflows of £1.3bn in 2018.
Changes occurring and improving fundamentals
The European Central Bank (ECB) has followed the dovish tone of others in 2019 by making moves to inject growth into Europe. These moves have come in the shape of cutting its deposit rate to -0.5 per cent in September 2019, while also bringing back quantitative easing.
We’ve also seen a change at the top of the ECB, with Mario Draghi’s tenure coming to an end in October, and former International Monetary Fund chief Christine Lagarde taking over at the helm. A recent note I read from Lazard indicates change may be on the agenda, with Lagarde likely to move away from solely relying on monetary policy, by encouraging eurozone governments to boost spending.
While it is far from being solved, there is also something of a respite from the overhanging threat of geopolitical uncertainty in Europe. We’ve seen a General Election in the UK , which finally gives Boris Johnson and the government the mandate to agree a Brexit deal – hopefully minimising the threat of a no-deal scenario on markets, while the phase-one agreement between the US and China has also been beneficial. Both situations can still turn sour, but for now - no news is good news.
Importantly for Europe, the underlying fundamentals look reasonably attractive. Unemployment levels in the EU stood at 6.3 per cent in November 2019, the lowest level since January 2000, according to Eurostat. Tighter labour markets are also slowly translating into higher wage growth. This, coupled with eurozone banks easing credit standards and inviting more lending, has indicated a better economic outlook than perhaps many of the headlines would indicate. As is often the case with Europe, this optimism needs to be tempered, and in this case, it is by high debt to GDP levels in the likes of France, Belgium, Italy and Spain.
Could there be an argument that we are actually in a sweet spot given that there is wage growth, low unemployment and money supply, while inflation is not at worrying levels?
Cutting through the noise to find opportunities
In addition to the underlying data not being reflected in the top-line negativity, I feel there are two additional drivers long-term investors should look to consider when investing in Europe. The first is: it is home to a number of leading global companies and, therefore, is not solely dependent on the continent, with approximately 40 per cent of revenues coming from overseas.
Secondly, European stocks are still undervalued compared with many other parts of the globe, particularly the US. This is a trend which has remained consistent since the global financial crisis of 2008 (the eurozone crisis of 2010-12 resulted in a delayed recovery in the region). According to FactSet, the MSCI EMU index (European Economic and Monetary Union) is on a 17.5x price-to-earnings ratio compared to 19.1x for the S&P 500.
There are clear value opportunities. Indeed, the divergence between quality/growth and value has surpassed levels seen during the TMT (technology, media & telecommunications) crisis and the global financial crisis. An article by Invesco head of European equities Jeffery Taylor highlights this point by stating there are plenty of examples of outperformance being driven by “re-rating rather than fundamentals alone.
Markets began shifting towards value in Europe in the last quarter of 2019, but the big question is, can this turnaround be sustained? Schroder European Alpha Income fund manager James Sym believes the shift has been positioning-led and that a regime change in markets and shift in mindset from policymakers could mean the shift to value lasts.
Sym says it is a classic business cycle call to buy economically sensitive stocks when the purchasing managers’ index (PMIs) are low amid a pessimistic consensus. He cites oil & gas and banks as two sectors which look particularly compelling, adding the latter does not need to see bond yields rise too much for a change in sentiment. However, he does believe some highly valued areas of the market, such as technology also offer opportunities.
In summary, I would not be foolhardy enough to tell you we’ve seen the low point in Europe, as history has taught us to expect the unexpected. What I would say is we support the view that it is undervalued and currently have a 20 per cent allocation to the region in our managed funds. Importantly, it seems the market may be starting to see the opportunity as well, with Morgan Stanley’s chief European economist Graham Secker saying they have just started to see some inflow back into the region after “85 weeks of consecutive outflows totalling $150m”. As a sector, it’s a classic example of one investors will have to be patient with, and take the rough with the smooth.
Sym’s Schroder European Alpha Income fund is one to consider for those looking to tap into Europe. His pragmatic style means he is not wedded to a particular investment approach. The 30-50 stock portfolio favours stock ideas which have a lot of potential to do well, but are less likely to fall on hard times.
Another to consider is the RWC Continental European Equity fund, managed by Graham Clapp. This fund is also style agonistic and is designed to find companies where financial performance will be better than the market expects. The average stock size is usually around 3 per cent, which prevents any one stock from dominating the portfolio. It also has a high active share.
Another with a value discipline is the Marlborough European Multi-Cap fund. Managers David Walton and Will Searle offer access to much smaller companies than many of their peers. These businesses are often overlooked and hence have the potential to outperform. This can carry extra risk, but the managers look to diversify in terms of sector and country.
Darius McDermott is managing director of FundCalibre and Chelsea Financial Services. The views expressed above are his own and should not be taken as investment advice.