Expect European upside in 2018 if corporate progress continues
Dean Tenerelli, portfolio manager of the T. Rowe Price Continental European Equity Fund
The foundations for investing in Europe in 2018 are more solid than they have been for a number of years. Corporate results have been reasonably encouraging over the past year, although the appreciation of the euro has created challenges. The market context is also becoming more positive, with political developments over 2017 largely market-friendly.
Sentiment towards Europe is more optimistic and flows have improved from both overseas and European investors. However, there remain risks – including Brexit, continuing political and financial uncertainty in Italy and Spain, the cloudier US policy outlook and persistent concerns about the downside risks to growth in Asia.
In our view, in an environment where many asset classes appear to be at least fully valued, further upside to European equities can be justified if progress on the corporate front can be sustained over the next couple of years. However, we would also highlight our valuation approach is, we believe, conservative, and it has become harder over the last year to find stock-specific opportunities offering material upside on our approach.
Whatever the prevailing economic and market conditions, we will stick to our investment philosophy and process. Despite a general increase in valuations, we continue to find good opportunities, but they remain stock specific and there is no unifying style, sector or country characteristic. For example we have recently initiated a position in a Spanish housebuilder, a Dutch ingredients business and a German online platform.
James Rutherford, head of European Equities at Hermes Investment Management
The key question for European markets in 2018 is whether the earnings renaissance we have seen this year can be sustained. After a decade when Stoxx 600 earnings have declined, 2017 is set to break that trend and deliver double-digit earnings growth. Estimates for 2018 are rapidly changing, but current consensus is around 8% growth. Delivery of earnings growth is paramount for investor confidence.
Economic growth has been returning to the eurozone and we believe the 2017 GDP print will be 2.2%, which would mark a post financial crisis high. Hard and soft economic data points are encouraging, unemployment is near lows and the recovery is broadly spread.
This renewed confidence is feeding through to corporates, M&A has picked-up, IPOs continue to come to market and investment decisions are being made. Allied Irish Bank’s successful return to market in 2017 is a great barometer of European economic progress and renewed confidence. One of the biggest casualties of the crisis, bailed out by the Irish government, buried under a mountain of non-performing loans but now back trading, and at a slight premium to peers.
No discussion of the European outlook is complete without a reference to politics, and the seemingly endless cycle of European elections continues in Italy in the first half of 2018. The UK’s negotiations with the EU will continue, where intransigence is likely to be the over-riding theme.
Stuart Mitchell, fund manager of the SWMC European Fund
The outlook for European equities remains very positive. As the IHS chief market economist commented, ‘…the message from the latest Eurozone PMI is clear: business is booming’. Indeed, new manufacturing orders and job creation reached the highest level for 17 years in November. The German economy is especially strong, with the manufacturing index hitting the second highest reading on record. More important perhaps, our company visiting programme attests to a corporate sector that continues to outpace more cautious market expectations.
As we have noted many times before, the political backdrop in the Eurozone is somewhat more stable than many in the Anglo-Saxon world perceive. President Macron, for example, has been able to pass his controversial labour market reforms. These ‘revolutionary’ changes include, most notably, the decentralisation of collective wage bargaining. This will especially benefit businesses with fewer than 50 employees (95% of all French businesses) by allowing management to negotiate directly with employees rather than through a union body.
The outlook for the British economy, however, remains very challenging. The economy is suffering from a squeeze in real incomes with the collapse in sterling pushing up the cost of imported goods. Investment spending growth, furthermore, has begun to slow down rapidly, with many in the business world fearing that a trade deal with Europe may not be possible.
Most strikingly perhaps, European markets remain good value trading at an unusually large 36% Shiller PER discount to the US – many domestically-orientated companies trade at even heftier 50%+ discounts.