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European equities have staged a spectacular rebound: Since their March 2020 low, they are up by more than 60%. So far this year, they have gained more than 13%. Still, there is the perception that the European market has significantly lagged the US.
So, we are asking Peter Abbott, European equities portfolio manager:
When looking at equity fund flows, it is quite clear that investors have massively favoured the US and the bulk of flows has gone into US equity, global equity and then emerging markets. Europe until very recently was not receiving inflows. Investors have been attracted by the trillion dollar stimulus programmes in the US.
That explains a large part of the gains for US equities, which are now over 25% above pre-COVID levels in US dollar terms. I should note that investors based in Europe should take into account the depreciation effect of these massive packages on the US dollar. That means US equities are up by only 11.5% in euro terms, while European equities are up by almost 6%. So there is a lag, but it is not as wide as you might think.
However, it is fair to say that this situation has highlighted the difference in valuations that existed already before the COVID crisis: European equity is clearly cheaper than US equity, where quite a lot of the optimism has already been priced in. So, from that perspective, I would expect there to be considerable scope for Europe to catch up.
Yes, of course. Something that is often overlooked is that European companies are the most internationally diversified companies of all the regions in the world. When you look at where companies are making the bulk of their sales and profit, European companies are the most exposed to global growth, more specifically to growth in the US, in China and in emerging countries. They are particularly well positioned for a broad economic recovery.
Looking at the latest earnings news, which was generally good, the market response implies a lot was already priced in. Concerns over inflation have also had an effect. Overall, we have seen optimistic comments on the demand recovery from companies in their latest earnings reports, although supply bottlenecks have impacted margins in some sectors.
Most companies, however, now think they have pricing power and the ability to manage costs, and want to increase capital spending and capital returns. We believe the market’s future direction now depends on the quality of the companies and their ability to deliver earnings over an extended period. That will sort the wheat from the chaff.
First, let me say that we are stock pickers. We assess the companies we invest in in depth, but we do not pretend to have any edge in predicting market direction and even less style rotation. We try to keep a balanced portfolio with a market beta close to 1, that is, we are not betting on the market being up or down. In terms of style, we cannot always be neutral and given our approach, we have more of a quality bias. In recent market conditions, such a quality focus has not been cheap, especially when you consider the market has been favouring what we believe are low-quality companies – the companies that lagged in 2020 as well as those companies that had a lot of debt.
On the rotation to value and cyclicals, we believe a sustained value rally is very much linked to the direction of yields and thus to long-term inflation expectations, but let me reiterate that we aim for the portfolio to outperform on company fundamentals and not on macroeconomic developments.
We have selectively added to value, but given the recent sharp rally in many companies in this category, we retain a measure of caution since we have some doubts about their ability to sustain that performance. We will adjust the risk profile of the portfolio to accommodate potential investment opportunities as they arise, as we did throughout last year.
We invest in the belief that superior longer-term share price performance is driven primarily by above-average, sustainable earnings growth over the medium term. Critically, we believe a company’s ability to achieve such earnings growth across economic cycles is determined by the structure of the industry in which it operates and the company’s position within that industry.
So, for instance, we would target a leading provider of semiconductors supplying electric carmakers and makers of wind turbines and solar panels – areas that should see long-term secular growth as we move towards a low-carbon world. Another example would be a global food player that is shifting from mainstream products to more premium and health-based products.
For both companies, we would of course also assess their environmental, social and governance performance as part of our commitment to have a portfolio with an ESG score above that of its benchmark and a carbon footprint lower than that of its benchmark.
Also listen to the podcast on the outlook for European equities with Peter Abbott
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
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This material is produced for information purposes only and does not constitute: 1. an offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. investment advice. It does not have any regards to the specific investment objectives, financial situation or particular needs of any person. Investors should seek independent professional advice before investing, or in the absence thereof, he/she should consider whether the investments are suitable for him/her.