2016 will be remembered as the year when the populist vote triumphed. While Britain’s vote to leave the European Union in the June referendum could have been dismissed as a one-off, Donald Trump’s victory in the US presidential elections showed that a shift in the West towards protectionism is here to stay.
These votes reflect a fundamental shift in public sentiment and a profound dissatisfaction with ruling ‘elites’. How governments respond will have material implications for global economies.
The Brexit vote and Trump’s victory both triggered market rotations, which are still playing out today. In the case of Brexit, investors have bought international earners in the UK and sold off domestic stocks.
In the US, prior to the presidential election, cautious investors were favouring low volatility stocks. Following Trump’s win, this trend reversed. The new president and his team have signalled their intention to create a programme designed to stimulate the US economy. The stimulus package is expected to take the form of tax cuts and a sharp increase in infrastructure spending.
Bond yields rose accordingly, and many construction related stocks saw an increase in value. Financials also benefited from expectations that a steepening yield curve and stronger credit formation would improve profitability.
December 2016’s Italian referendum was another decisive victory against a ruling party. However, the vote rejected Matteo Renzi’s reforms, retained the constitutional status quo and prompted Renzi’s resignation as prime minister. Italy now has a new prime minister and the technocratic government is likely to adopt different voting reforms before a general election expected in 2018.
The rise of the populist vote will continue to dominate the political agenda in 2017 as we see elections across Europe. The risks and uncertainty involved in these votes are far more material than in recent cycles.
Will anti-establishment, protectionist rhetoric be victorious in the French presidential election, the Dutch general election or the German federal elections? Or will we see pro EU, pro capitalist right wing governments elected or re-elected?
Either way, we are likely to see changes in the way the EU is run as the electorates’ mood has shifted in multiple ways. We should also be mindful of the resilience of the UK economy (at least thus far) to the Brexit vote and the positive market reaction to the Trump election.
Other related unknowns that lie ahead are the negotiations around Brexit, the reality of the Trump presidency and his specific policy plans, Europe’s monetary policy direction and how inflation develops.
Growth and attractive valuations
Against such an uncertain political backdrop, we would point to the positives in Europe.
We see reasonable economic growth of 1.0% in the UK and a continuation of the weak European recovery, with Eurozone GDP rising by 1.1%. Inflation of around 2% in Europe should help companies’ top lines and we see growth of around 10% in earnings for the European market in 2017.
Another area of comfort is that European valuations are relatively attractive today. Risk aversion to upcoming political events has led to a surge in outflows from European stocks and left the equity market at a material discount to the US, in particular.
For example, the European market dividend yield is around 3.5% and many good quality stocks are yielding much more. We also see attractive valuations in the small and mid-cap space as investors focus on the risks rather than the exciting growth prospects on offer.
As investors, we focus on higher-quality companies with positive long-term prospects. We are firmly focused on the business models of the companies we invest in, as well as the broader merits of their respective sectors, using Porter’s Five Forces analysis to evaluate the strength of a company versus its competitors.
This can mean that many of our stock picks are intrinsically lower beta within their respective sectors. We also continue to invest in disruptors and companies that can benefit from various changes in market themes.
Currently these factors include the improving underlying economics noted above and the enduring changes in financing conditions with the recent changes bond yields. The improving European macro-economic situation should help a number of areas including construction, chemicals and industrials, where some of our investee companies are beginning to enjoy some revenue tailwinds.
Within financials, the steepening of the yield curve has significant benefits for insurance companies and traditional banks, which should help earnings in the financials to improve during 2017
Opportunities in an unstable world
Our approach does not change as we enter 2017, a year of diverse risks.
The stocks we own in our diversified portfolios are those that are strong enough to withstand the short term buffeting of markets and politics and can prosper on a multi-year view.
In the changing environment, we continue to search for new opportunities. Macro-economic uncertainty may be unsettling but it can give the active manager real opportunities when new news wrong-foots the market. The shortterm reactions to geopolitical events do not necessarily reflect the way that the situation will play out longer term and we will aim to take advantage of market volatility to buy good quality stocks at unwarranted discounts.
Philip Dicken is head of European equities at Columbia Threadneedle Investments