So we ask Peter Abbott, the portfolio manager for European equities:
Should investors expect Europe to catch up?
If you look at equity flows from equity funds, it’s pretty clear that investors have massively preferred the US, and the bulk of the capital flows have gone into US stocks, global stocks, and then emerging markets. Until recently, Europe received no inflows. Investors were drawn to the trillion dollar stimulus programs in the US.
This explains much of the gains for U.S. stocks, which in U.S. dollars are now over 25% above pre-COVID levels. I should note that European based investors should consider the depreciation impact of these massive packages on the US dollar. That means US stocks are up only 11.5% in euro terms, while European stocks are up almost 6%. So there is a delay, but it is not as great as you might think.
It must be said, however, that this situation has made clear the valuation differences that already existed before the COVID crisis: European stocks are significantly cheaper than US stocks, which have already priced in much of the optimism .
Besides the US stimulus plan, are there any other factors propping up European equities?
Yes, please. What is often overlooked is that European companies are the most internationally diversified companies of any region in the world. If you look at where companies get the bulk of their sales and profits, European companies are most exposed to global growth, particularly growth in the US, China and emerging markets. They are particularly well positioned for a broad economic recovery.
What can stimulate the European market?
Looking at the current overall good profit news, the market reaction suggests that much was already priced in. Concerns about inflation have also had an impact. Overall, we have seen bullish comments on the recovery in corporate demand in their recent earnings reports, although supply shortages in some sectors have impacted margins.
However, most companies believe they have pricing power and the ability to control costs and want to increase their capital expenditures and ROI. We believe that the future direction of the market now depends on the quality of companies and their ability to generate profit over a longer period of time. That separates the wheat from the chaff.
How do you rate the market rotation in cyclical and value stocks?
First, let me say that we are stick pickers. We thoroughly evaluate the companies we invest in, but do not pretend to have a head start in predicting market direction and even less style rotation. We try to keep a balanced portfolio with a market beta close to 1, meaning we don’t bet on the market going up or down. When it comes to style, we can’t always be neutral and, because of our approach, we tend to be more quality-oriented. In recent market conditions, such a quality focus hasn’t been cheap, especially considering that we think the market has favored low-quality companies – the companies that lagged in 2020 as well as companies with high debt.
With the rotation to value and cyclical values, we believe that a sustained value rally is strongly related to the development of returns and thus to long-term inflation expectations macroeconomic developments.
We have been selectively increasing in value, but given the recent strong rebound in many companies in this category, we remain cautious as we have some doubts about their ability to maintain that performance. As last year, we will adjust the portfolio’s risk profile to reflect potential investment opportunities as they arise.
How do you choose promising companies for your portfolio?
We invest in the belief that superior longer-term share price performance is primarily driven by above-average, sustainable medium-term earnings growth. Crucially, a company’s ability to achieve such earnings growth across business cycles is determined by the structure of the industry in which it operates and the company’s position in that industry.
For example, we would target a leading supplier of semiconductors that supplies electric car manufacturers and manufacturers of wind turbines and solar modules – areas that should grow in the long term as we move towards a low-carbon world. Another example would be a global food company that is moving from mainstream products to premium and health products.
For both companies, we would of course also rate their environmental, social and governance performance as part of our commitment to have a portfolio with an ESG score above its benchmark and a lower carbon footprint than its benchmark.
Also listen to the European Equities Outlook Podcast with Peter Abbott
All views expressed here are those of the author at the time of publication, are based on available information and are subject to change without notice. Individual portfolio management teams can have different views and make different investment decisions for different clients. The views expressed in this podcast do not constitute investment advice in any way.
The value of investments and the income from them can go down as well as up and investors may not get back their initial outgoings. Past performance is no guarantee of future returns.
Investments in emerging markets or specialized or restricted sectors are likely to be subject to above-average volatility in market conditions (social, political and economic conditions) due to high concentration, greater uncertainty due to lower information availability, lower liquidity or greater sensitivity to changes.
Some emerging economies offer less security than most international industrialized countries. As a result, portfolio transaction, liquidation and preservation services on behalf of funds invested in emerging markets may involve greater risk.