European equity opportunities continue to present themselves
In a world where global growth is clearly weaker than had hoped for and where political events pull on investor sentiment, it can be hard for investors to know where to turn. While some European sectors and companies will be negatively affected by the weakness in global trade, slowdown in China and other emerging markets, on balance, while the recovery in Europe continues, albeit slowly, there are opportunities to found in European equities.
Most recent macroeconomic indicators show that the eurozone economy remains relatively resilient. Domestic demand remains strong, fueled by low oil prices, a lower unemployment rate and cheap financing conditions. Interestingly, recent GDP figures show that investment has actually been the main growth engine, taking over the baton from consumption. Even regional sentiment indicators which may have been more significantly affected by market volatility show signs of resilience.
A convincing package of ECB measure has certainly helped. The extension of its QE program, both in pace and scope, together with four new TLTROs creating more appealing conditions for banks, should further decrease financing costs and boost credit growth in the region.
From an investor perspective, it’s true that valuations of European equities aren’t cheap on an absolute basis. They are closer to fair value currently, but valuations are already accounting for an overly gloomy earnings growth outlook. Indeed, earning expectations could be gradually revised up as the global economy stabilises as a result of a more dovish Fed, to pro-cyclical measures implemented in China and to the stabilisation of oil prices. Compared to other markets, European equities are even more appealing as the MSCI Europe dividend yield is currently close to 4%.
At present there are opportunities to be found particularly in the capital goods sector, for instance, as the long-term outlook for the renewable energy market remains positive. Growth is also likely to be supported further following the recent extension of the production tax credit in the US for a further five years. Vestas Wind Systems, the Danish manufacturer of wind turbines, is a company benefitting from this. The company remains well ahead of analysts’ forecasts and by having a high market share and diversified geographic exposure compared to its peers the company looks set to weather the storm and deliver strong profits.
The domestic consumer is also showing considerable strength in Europe. New registrations of passenger cars grew by 13% year-on-year (y/y) in December 2015, the fastest rate of growth since March 2010, at the same time retail spending rose by 3.0% in the third quarter of 2015 y/y, the fastest rate of growth in over two years. While consumer confidence, particularly in the periphery, reached multi-year highs in the last six months of 2015.
With personal consumption now accounting for 56% of the European economy, these recent improvements will drive regional growth. But this may not be fully reflected in the stock market going forward, given that consumer-related services make up only 29% of the total profits of the Stoxx 600.
It is possible to construct a portfolio that is reflective of improving economic conditions within the eurozone and is protected from the disproportionally large impact that commodities and manufacturing has on the main Stoxx 600 benchmark. But this can only be achieved by careful sector and company selection, reinforcing the case for active management.
It is likely that the outcome of the EU referendum will preoccupy headline writers over the next few months, but this isn’t overly concerning at this stage however, as markets are sufficiently efficient to have discounted the current probability of a UK exit, so if evidence emerges suggesting that the UK will remain in the EU this should support the prices of stocks in affected sectors, such as housebuilders.
At the same time, concerns over migration will continue to overshadow the domestic debate, and investors will carefully watch the portents for emerging market growth.
If one thing is for certain, the broader the investment opportunity set, the greater the alpha opportunity. Having a focus on stock selection provides insight into alpha drivers in every size segment in the market. The consistent application of this philosophy across a broad investment universe is expected to continue to generate consistent returns in the future – just as it has in the past.
Stephen Macklow-Smith is portfolio manager of the JPM Funds – Europe Equity Fund, at JP Morgan Asset Management