Why Should Investors Still Consider Europe?
In this video update, Alex Crooke, Co-Head of Equities – EMEA and Asia Pacific, provides a broad overview of global equity markets and reflects on the chances of markets rebalancing following significant U.S. equity outperformance. Mr. Crooke also examines some of the issues facing Europe, including Brexit, and why equity investors should still consider the region.
- Despite global challenges – trade tariffs, inflationary concerns and rising U.S. rates – robust economic activity is providing a decent backdrop for corporate earnings.
- Following recent U.S. market outperformance, a rebalancing is more likely to come from a re-rating of European markets on the back of increased confidence in international (ex U.S.) earnings.
- European equities appear attractive in valuation terms, notably energy, materials and financials, helped by “easy” monetary conditions in the region.
Alex Crooke: First of all, if we think of the economic activity, it is still pretty robust around the world, GDP is solid, we are seeing consumer numbers being reasonably solid, and corporate and trading activities. So that is leading to a strong background for corporate earnings. But actually there are some changes on the horizon. The most obvious one is trade, tariffs and the trade imbalances around the world. And I think our view is really not going to get any better. We are not going back to where we were, in the sense that if we look at the great financial crisis 2008, we did see crushing blows to the banking system. And actually the number of sort of global banks operating around the world is declining. We are seeing markets being more about the financial institutions that sit there rather than global trade driving things. So we look at that when we are looking at companies, and I think that is important. But the end users are still solid, companies will find ways of manufacturing and getting around trade tariffs.
I think the other S/B aspect that is clouding the outlook is inflation picking up and therefore rates rising. We still have got, though, very easy monetary conditions around the world, particularly in Europe, Japan. So again I think a little bit of inflation is very manageable for companies. It allows them to book prices up and their wages are growing, but again, companies who have a history of showing they can adapt to these systems.
I think in terms of rebalancing of investment returns from global stocks relative to the U.S., it is not going to come about the U.S. falling and international markets rising, it is more going to be about confidence and the earnings internationally and therefore, a re-rating situation. The difference between the U.S. equity market rating and international is quite stark. So I think that is where we need to look at how much confidence will people have in international earnings, being maintained, growing again, and as I said earlier, I think monetary conditions are very easy internationally. Inflation is pretty much under control, 1% to 2% rates are still very low. I think that can come about, but it is an evolution, it is not an instant fix one quarter.
In terms of Europe, specifically, there are obviously some countries where we’ve seen a lot more political noise, rising populism and obviously that really is most borne out in Brexit in the UK leaving the economic union. I think our views, again, here, that rising populism, at the end of the day, across Europe, it is not necessarily about leaving the euro, it is about economic returns, I suppose wages, etc., etc. That is a political issue. I don’t see Europe breaking up, fracturing further. But I think in terms of Brexit, specifically, we do expect the negotiations to still be very hard fought, right to the last hour. And, therefore, expecting good news to come and flow occasionally, but at the end of the day, we have got to wait for a proposed deal to see whether that can get voted through parliaments. That will be quite difficult still.
I think Europe should be considered for maybe increasing investments. I think the reasons stand behind that certainly of valuation, value looks good in this market, cash flow is underpriced, earnings, I think, are underpriced. I expect a growing confidence, actually the world is not broken, trade tariffs will get sorted out between various parties, and goods will still move across the world. So I think that is key. Monetary conditions are also very easy. The interest rates are not rising, continental Europe I don’t expect them to rise, particularly in the UK, and inflationary conditions are under control. So, I think, monetary conditions look also very attractive. I think certain sectors are very underpriced as well. Energy and materials look to us a good area as not being increasing capital expenditure invested in those areas and actually demand is good. So if not, if new oil fields and gas fields are not coming online, if new minds are not being opened, we should see increasing price pressure upward and margins under control.
And the other area is probably financials. Again, cloudy with a lot of uncertainty, the rising rates, certainly in the U.S., rising long-term rates of inflation are picking up a little bit, should allow financial institutions to earn a little bit more margin and that should come through in increased confidence and therefore, those valuations.
Foreign securities are subject to additional risks including currency fluctuations, political and economic uncertainty, increased volatility, lower liquidity and differing financial and information reporting standards, all of which are magnified in emerging markets.