Equity markets will finally see positive fund flows
European equities are likely to benefit from the broadening of the global recovery.
As rising inflation reduces the attractions of bonds and cash, equity markets should profit from positive fund flows for the first time in years. With austere fiscal policy being the main tool available for deficit reduction, economic growth in the eurozone is likely to remain sub-trend for some time.
That will mask huge contrasts with states that manufacture and export doing better than those that consume and must repay debt. It is a continent of contrasts, meaning expectations and valuations are lower for firms exposed to the domestic European economy.
While there is positive evidence supporting markets overall, investors should be mindful that such generalisations are too blunt a tool when it comes to constructing a successful portfolio. Contrasting fortunes both across and within markets mean investors need to look carefully at the outlook for individual sectors.
Investor expectations are already high for certain sectors of the market. This is especially true of capital and luxury goods stocks where, despite recent weakness, many stocks are valued at a significant premium both to their own history and the wider market. They also seem to be discounting structurally higher returns and lower volatility than we have seen in the past.
The banking sector continues to face stiff headwinds from the stricter regulatory environment, the need for further capital reserve building and the risk of further asset write-downs. However, more positively, valuations already discount this and with a sense of a solution to the European sovereign debt crisis beginning to emerge, there are reasons to be less negative on banking than in the recent past. The software and service sector is likely to benefit from corporate investment.
In hardware, the promise of mobile internet is just beginning and many firms are at the forefront of the investment wave. In pharmaceuticals, share prices are already discounting bad news such as expiring patents and US healthcare reform, while there are positives on the horizon including the scope for companies to cut costs.
John Botham is fund manager and desk head at Aviva Investors