Europe’s Value & Income Opportunity
In this video update, Ben Lofthouse, Head of Global Equity Income (GEI), discusses the reasons behind the divergence in global equity markets, the impact this has had on equity income investors and where he sees value in the markets and opportunities for dividend growth.
- GEI strategies, which have historically obtained higher yields from regions outside of the U.S., have been impacted by U.S. equity market outperformance.
- Investor concerns relating to Italian elections and Brexit have created a “fantastic” value opportunity within Europe.
- Market uncertainty highlights the need to diversify by county and sector across a range of companies trading at attractive valuations.
- Dividend growth expectations appear underpinned by strong cash flow from corporate earnings.
Ben Lofthouse: 2018 has been a year of extreme divergencies between different equity markets around the world. The economic growth outlook has not changed significantly over the period and the big change has been around sentiment. We have seen a number of things happening this year, which has weakened confidence, particularly for U.S. investors to invest overseas. One of those is the trade talks. This has definitely been something that has started off as what was assumed as a negotiating tactic, but which has built into something that feels more permanent. And this has definitely affected some of the emerging markets and Asian markets particularly. And on top of that, we have had U.S. interest rates going up and traditionally, historically, this has quite often been linked to weakness in currencies in emerging markets.
The more, the bigger detractor for equity income products, is that we get higher yields from many regions outside the U.S., often for similar types of stocks. And so things like chemicals, banks, quite often you have high yields in areas like the UK and Europe. What we have seen in sentiment on those areas is a significant increase in concerns around Europe. This is mainly down to Italian elections and the new Italian coalition, and also the ongoing kind of concern around Brexit. Now on both of these issues, there is still significant amount of resolution needed. In terms of the stocks, they have valued in a very significant valuation differential and so we think there is a fantastic value opportunity. This feels very like a few years ago when we had issues around Greece and these were good buying opportunities. But what is very hard to tell is when it resolves. There is certainly a timeline for Brexit to resolve itself by early next year, so we will see headlines on there. And the European beauty in the budgetary procedure for Italy is going to go on through the end of this year. So is it going to suddenly banks, it is hard to say. Is a lot priced in? Yes.
I think what is positive is that the cash flow for companies is coming through very strongly. So in this environment, in areas that you might normally associate with concerns in a time when the market has been weak, so mining, oil, financial services, European banks, we have seen strong dividend growth and a significant commitment to dividends, because actually in many cases the balance sheets are much stronger than they were a few years ago. The financial services sector, for example, for Europe has raised significant amounts of capital and has retained significant amounts of profit in recent years, so it has much higher capital ratios. The oil companies and the mining companies have generated significant amounts of cash and have (inaudible) their balance sheets.
So I think underlying, the companies are not feeling the level of uncertainty that is represented in the market. So all in all, it has been a tough year for a relative performance, because overseas equities have been impacted so much by the sentiment, but underlying, we are still seeing good dividend growth coming through.
So in terms of outlook for the end of the year, we are cautiously optimistic on overseas equities. We have seen a significant de-rating in a number of income-generating areas, such as telecommunications, that give more value there than they have done for the last few years. I think in terms of some of the political things we have seen, some of the tariff resolution within the North American Trade Agreement. We suggest that we might get more tariff agreements as we go through to the end of the year. But I think there is still a considerable amount of uncertainty and one of the ways to protect against that is to have an attractively valued portfolio. And the other area, thing to do, is diversify. For example, how do you diversify against some of the trade issues? Well, one thing is to look for maybe domestic stocks that are not affected as much, things like telecommunications, perhaps, pharmaceuticals. Another is to diversify, so again, if you hold the financial services sector, why not hold it in a number of different countries or a number of different regulators, so that you can diversify the risk there should there be a particular adverse trade relationship that occurs or changes, or should there be adverse economic impacts from some of the factors that we have talked about earlier.