November 30, 2019
Swimming Against the Tide
November 30, 2019
The dark clouds of gloom that hung over Europe at the start of the year have failed to dissipate, if the tidal wave of flows out of the asset class is anything to go by - see Display 1. Concerns over a U.S. slowdown, concerns of first higher, then lower, interest rates, concerns over the political environment in the EU, concerns over a tariff war between the U.S. and China, fears over Brexit. The list goes on. And on. It would appear that whatever investors were worrying about, Europe was implicated in some respect.
Source: Exane BNP Paribas. Data as of 31 October 2019
A quick glance at the performance of Europe’s stock markets so far this year tell a very different tale, however. In Euro terms, France’s CAC 40 Index and Germany’s DAX Index have risen 25%, while the supposedly ‘defensive’ Swiss Market Index is up nearly 30% as of the end November 2019.1 It would appear that some investors have been put off by images of the protesting ‘gilets jaunes’ in France or by concerns of the potential impact of tariffs on Germany’s exporters, rather than the underlying economic reality in Europe currently.
The truth is, Europe is doing rather well and is far from a dull backwater to be avoided, as the bears would have us believe. There seems to be an unwarranted notion that Europe is sclerotic. Challenged, economically. This is unwarranted as, for example, a comparison of the growth in GDP per head illustrates. From 1999 to 2017, real GDP per head rose by 21% in the U.S.2 In Europe it rose by 25% over the same period.2 Hardly evidence of a stagnating economy.
Let’s not forget that Europe is the most affluent trading bloc on the planet. Ranked by GDP per capita, 15 out the top 20 OECD countries are European nations. Take a stroll along Bahnhoff Strasse in Zurich, down the Champs Elysees in Paris or through the Arkaden in Munich and it rapidly becomes evident that Europe is a wealthy, stable, modern region that functions smoothly and efficiently. Consumer confidence has grown as unemployment has fallen post the Global Financial Crisis. Politically, Brexit notwithstanding, Europe remains stable, broadly centrist and free from extreme political leaders at the extreme edges of the political spectrum. It has rational, functioning institutions, e.g. the ECB. With U.S. elections looming next year, political risks in Europe are likely to abate just as they begin to increase in the U.S.
At the corporate level, Europe is in the privileged position of benefiting from a well-diversified revenue stream outside of its home markets, with a significant exposure to emerging markets, as well as exposure to the U.S. and the Middle East. By definition, therefore, it offers diversification in the event of a slowdown in a particular region while remaining geared into a rebound in global growth.
A fact often ignored is the plethora of world leading companies Europe has to offer. From industrials to materials stocks, from discretionary to technology and healthcare, many European companies lead the world in what they do, delivering high and consistently sustainable levels of returns and benefitting from structural global themes such as demographic changes and a rapidly growing middle class, for example. These are precisely the type of characteristics we search for when investing in Europe. Some firms are household names, but many are not. It is highly likely that consumers around the world, who may not be familiar with the names of such companies, will nevertheless come into regular contact with the products of those corporations, often on a daily basis.
Valuations are an important part of any investment decision. Naturally, different markets have differing sector compositions but even considering this, European equities look attractive relative to other equity markets and other asset classes. The discount to U.S. equity valuations, for example, has deepened and reached extreme levels [>2 standard deviations (SD)] recently - see Display 2. Given the health of the European region and the strength of many companies domiciled here, this appears unjustified in our view.
Source: Barclays. MSCI Europe Price/Book Vs U.S. Data as of 29 November 2019
As retail and institutional investors have left or shunned European equities and are now firmly underweight the asset class, investing here can feel as if one is swimming against the tide at times. But that creates opportunities for those prepared to look beyond the soundbites and headlines. And the beauty of tides is that they turn.
1 Bloomberg, November 2019
2 Martin Wolfe, Financial Times, 16-17 November 2019
There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline. Accordingly, you can lose money investing. Please be aware that this portfolio may be subject to certain additional risks. In general, equities securities’ values also fluctuate in response to activities specific to a company. Investments in foreign markets entail special risks such as currency, political, economic, market and liquidity risks. The risks of investing in emerging market countries are greater than the risks generally associated with investments in foreign developed countries. Illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks. Concentrated investments in Europe are more susceptible to such risks affecting European issuers than a Portfolio that holds more geographically diversified investments. Focused Investing. To the extent that the Portfolio invests in a limited number of issuers, the Portfolio will be more susceptible to negative events affecting those issuers, and a decline in the value of a particular instrument may cause the Portfolio’s overall value to decline to a greater degree than if the Portfolio were invested more widely.
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