Ignoring European equities at your peril?

Investors have fallen out of love with European equities, having seen returns blighted in the past decade by the Sovereign Debt Crisis and, more recently, trade wars, Brexit and the rise of populism.

During a period when market stimulus has propelled the global economy into the longest bull market in history, European equities have been one of the least rewarding places to be. A return of 107%^ in a decade is not exactly a disaster, but investors will still feel they have missed out when you consider global and US equity markets have returned 213%^ and 313%^ respectively over the same timeframe.

The start of 2019 saw the outlook for Europe go from bad to worse, as disappointingly weak economic indicators kept rolling in. Recession was the buzzword amid all the negativity, but the market showed its resiliency in the end, rising almost 20%^^ amid the uncertainty. However, this has not swayed investors who pulled £4bn from European equities in the last calendar year to the end of November^^^.

But opinion – at least among some professional investors - is starting to change. Barclays, for example, shifted its focus from US to European equities in 2020. Emmanuel Cau, head of European equity strategy for the company, said: “For 2020, we believe that Europe and U.S. equities offer broadly similar upside, but we see the balance of risks around our constructive macro scenario consistent with a tactical preference for Europe vs. the U.S. We find current European equity valuations attractive compared to the U.S.”*

Three reasons why we too could be more optimistic

• Accommodative monetary policy: Like many other central banks globally, the European Central Bank (ECB) has looked to stimulate markets by bringing back quantitative easing and cutting interest rates. We’ve also seen a change at the helm of ECB with Mario Draghi being replaced by Christine Lagarde, former head of the International Monetary Fund. The incumbent is widely tipped to move away from monetary policy and encourage euro zone governments to start spending. This is a story which could ultimately boost economic growth in the longer-term, as infrastructure spending often takes time to implement.
• Geopolitical tensions calm, for now: 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 gave Boris Johnson and the government the mandate to agree a Brexit deal, while the phase-one trade agreement between the US and China has also been beneficial. Both situations can still turn sour, but for now: no news is good news.
• Underlying fundamentals for Europe remain attractive: Importantly for Europe, the underlying fundamentals look reasonably attractive. Unemployment levels in the European Union stood at 6.3% in November 2019, the lowest level since January 2000**. Tighter labour markets are also slowly translating into higher wage growth. This, coupled with euro zone 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 Europe actually be in a sweetspot?

What do the fund managers think?

Janus Henderson European Focus and European Selected Opportunities fund manager, John Bennett, says that history suggest another strong year of returns in 2020, following the outperformance seen in 2019, “though with much more volatility and much lower general stock market returns.”****

He says: “It is often when things go from ‘bad’ to ‘less bad’ that the greatest market gains are realised. When things go from stable to ‘even better’, however, equities, have often already anticipated part of that improvement.”

Markets began shifting towards value investing in Europe in the last quarter of 2019, but the big question is whether this turnaround can 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.

James 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.*****

Marlborough European Multi-Cap Income manager David Walton says that, despite ongoing threats to world economic growth from ongoing trade deal negotiations (both US/China and UK/EU) and the recent events between the US and Iran, the IMF is expecting to see a slight rebound in growth for 2020. IMF European GDP growth forecast is 1.8% for 2020 citing a pickup in external demand.

He says: “During the last few months of 2019 the fund saw three takeover bids (Cramo at a 30% premium, Swedol at a 30% premium and Data Respons at a 20% premium). This demonstrates that there are still attractive companies across Europe which remain undervalued. We believe that these opportunities are most prevalent in the less well researched smaller cap segment of the market.”******

^Source: FE Analytics, total returns in sterling, 19 February 2010 to 21 February 2020, using S&P 500, MSCI World and MSCI AC Europe.
^^Source: FE Analytics figures from January 1, 2019 to December 31, 2019
^^^Source: Investment Association figures from 1 January 1 2019 to 30 November 2019
*Source: Financial Times
** Source: Euro stats Unemployment figures
***Source: Lazard Outlook on Europe 2020
****Source: Janus Henderson Investment Team Perspective (February 2020)
***** Schroders Outlook 2020: European equities
******Source: Marlborough Fund Managers fund commentary; European Multi-Cap fund (January 2020)