Investors fleeing Wall Street are increasingly turning to Europe in a continuation of last year’s trend, according to EdenTree’s Amity European fund manager Chris Hiorns.
Attractive valuations, Brexit uncertainty, Europe spare capacity and an accommodative monetary policy are among the reasons to favour the European asset class, the manager said.
“Europe is an area where investors are becoming more overweight on. It was last year when they increased European weightings and, in 2018, we continue seeing that preference for European equities.”
Indeed, as opposed to previous years when Europe was an unloved part of the market, the asset class enjoyed a decent run in 2017.
As the below chart shows, the MSCI Europe ex UK index made a 15.84 per cent total return in 2017, outperforming the 13.24 per cent made by the MSCI AC World.
Performance of indices in 2017
Source: FE Analytics
European equities also seem to be growing in popularity among investors. Data from the Investment Association shows Europe was the second most bought region, behind the IA Global sector, in 2017.
With US equity funds continuing to suffer redemptions - $22bn came out globally in the two first months of the year – and continental Europe seeing inflows to the tune of $15bn over the same period, investors seem to believe the European asset class has still a lot to offer.
For Hiorns , not only macroeconomic growth is on its strongest foundations since the credit crisis, but the European market also looks attractive compared to the US market.
“The European market is appealing because of the stage in the economic cycle Europe is at,” he said.
Referring to recent data showing the US economy added 313,000 new jobs in February, Hiorns noted unemployment in the US is on a 48-year-low, a fact that will soon see wages moving up and costs going up.
“While they have reached the end of the cycle, all major European economies are forecast to continue to expand,” the manager added.
“Forward looking indicators such as consumer, manufacturing and service sentiment are improving and rising towards new highs.”
However, things aren’t looking as rosy on the other side of the Atlantic, where president Donald Trump’s fiscal policy change is forecasted to move the labour share of the GDP up and the profit share of the GDP down.
According to Hiorns, spare capacity – a macro term that measures the extent to which an industry or economy is operating below the maximum sustainable level of production - is also going back to pre-crisis levels.
OECD growth projections
Source: OECD
“There is plenty of spare capacity in the European markets, we are going to see domestic growth starting to pick up in Europe,” he said.
When it comes to valuations, Hiorns noted valuations on this asset class remains attractive compared to US equities or European bonds, but also pointed out the asset class appears high by historic standards.
In addition, the manager highlighted the positive aspect of the still-accommodative monetary policy, which he noted will tighten, but very gradually given subdued government spending in the post-crisis period.
“After experiencing very tight fiscal policy in the aftermath of the credit crisis, there appears little appetite to tighten monetary policy counter cyclically,” he said.
However, given the complacency of the markets after many years of quantitative easing he acknowledged the possibility of an exaggerated impact on the economy if monetary policy tightens more rapidly than investors expect.
With the UK still in the eye of the hurricane, Hiorns also highlighted Brexit as a factor that will continue benefiting investment in European equities.
Indeed, the outlook continues to be weak for the country. The OECD said last week the UK will be the slowest growing economy in the G20 barring South Africa, not only that, with growth slowing from 1.7 per cent in 2017 to 1.3 per cent this year and 1.1 per in 2019.
Given his outlook and the current economic backdrop, value investor Hiorns said the sectors with the most attractive valuations are media, building materials and telecoms – the latter being the cheapest in valuation terms.
“For a long time, music companies were unable to monetise people using the internet but that is changing dramatically: we saw it with Spotify, we are seeing it in deals made with Facebook and with other internet-based music companies,” he said.
“Telecoms is the cheapest sector in valuation terms: we have had a lot of headwinds for the tech-communications industry, not only through EU regulation but because that regulation increases competition coming into the market.
“However, those trends have tended to reverse more recently and the EU regulators are now more worried about the large internet companies, about ‘the Amazons’, ‘the Googles’.
“The regulatory headwinds those companies were facing came to an end with roaming in June 2017, which was a hit for the telecom companies.”
Furthermore, he added, individuals are “increasingly using additional devices and more data”.
Performance of fund over 10 yrs
Source: FE Analytics
As a result, the manager has been increasing the allocation to telephone companies and internet services providers. EdenTree Amity European, fund he oversees with deputy manager David Osfield, has an 8.82 per cent allocations to the telecoms sector.
Over 10 years, the fund has delivered a total return of 136.06 per cent, compared with a 101.93 per cent gain for the average fund in the IA Europe Excluding UK sector and a gain of 101.09 per cent for the FTSE World Europe ex UK index.