Casting our minds back 12 months ago, we were optimistic about the prospects for European equity markets for 2019. This confidence was rewarded, with the FTSE Developed Europe Index jumping by almost 20 per cent – most of which was achieved during the first six months of the year. 
Even though 2019’s gains were significant, the year was characterised by heightened volatility. However, while market gyrations can often disturb investors, for pure bottom-up active managers such as ourselves, we welcomed a more turbulent market. Indeed, we were able to deliver robust outperformance over the index during the more volatile environment in 2019.
Fast forward to today and the broad outlook is less positive.
There are growth fears for a number of economies across Europe, many of which are struggling due to the slowdown in Germany – the bloc’s main economic engine. Germany continues to feel the pressure of stuttering Chinese growth – as the Asian powerhouse deals with its tumultuous economic relationship with the US. In addition, the coronavirus outbreak is also likely to have an impact on global growth this year.
Several parts of the European economy have experienced an industrial recession. This has been partly caused by the US and Chinese trade tensions, but also simply because we are in a late-cycle environment. Although there have recently been some more positive indications of activity, an industrial slowdown typically filters through to other areas of the economy, so investors should not expect any substantial growth pick-up for at least the current year.
Aside from the ongoing economic questions, political clouds also hover over the continent – not least the upcoming future trade discussions between the UK and the EU.
Resolute focus on fundamentals
Despite all these top-down concerns, as stock pickers, our primary focus is on company fundamentals and valuations. In these volatile conditions, we aim to build a relatively balanced portfolio in terms of exposures to possible economic scenarios, so relative performance is not dependent on a particular ‘macro’ environment.
While it is true valuations are near historical averages after the market rally of 2019, we are still finding a wide range of attractive investments.
In fact, a more volatile market and greater dispersion of returns provides us with additional relative opportunities to exploit. For example, we are optimistic on the prospects for a number of defensive sectors, which have the ability to show resilience should we witness continued uncertainty.
For those familiar with our European equity strategies over the past decade, we have generated considerable alpha by taking stakes in a number of overlooked opportunities in Spain and Italy.
We currently have a number of positions in regulated Italian and Spanish utilities, which we began investing in when cyclical sectors were in vogue and investors were largely dismissing defensive opportunities. These companies benefit from favourable regulatory regimes and offer an attractive and dependable income yield.
Healthcare is also one of our largest absolute and relative allocations. We believe many investors are underestimating the defensive growth potential of some stocks in this sector. We hold a range of high-quality pharmaceutical companies with excellent track records and growing pipelines of new products, which we expect to deliver steady earnings growth over the medium term.
Opportunities in pressured financials
On the flipside, we continue to hold a major underweight position in consumer staples – as valuations are broadly excessive in this sector. We are also underweight financials, as the outlook remains difficult and poor industry fundamentals are likely to continue for some time.
However, we have recently reduced the underweight to financials, as certain opportunities have become more attractive. For instance, we initiated a position in Nordea Bank, the largest financial services provider in the Nordic region, in the final quarter of 2019, as we anticipate improving return potential over the next three years.
We also continue to monitor banking markets still showing signs of growth, such as Spain. We also increased our stake in Spanish banking group Bankinter over the final quarter of 2019. Bankinter, which is among one of the best-capitalised banks in Europe, has a history of strong risk management and is committed to a high payout ratio. Earnings are also bolstered by fee income from its asset management business, which means Bankinter is better able to reduce the impact of net interest margin erosion in the current prolonged low interest rate environment.
Overall, investors should remain vigilant in 2020, as the equity market rally last year masked bouts of shifting sentiment and direction caused by numerous global and regional uncertainties.
However, while the broad market may struggle to meaningfully advance without concrete resolution of some of these issues, we remain bullish on the bottom-up alpha opportunities on offer for investors able to take advantage of what we expect to be a continued turbulent environment.
Dean Tenerelli is portfolio manager of the T. Rowe Price Continental European Strategy. The views expressed above are his own and should not be taken as investment advice.