It’ll be all change at the top of the European Central Bank soon, with the European Council officially nominating Christine Lagarde as the new chief earlier this month.
Lagarde, who has been managing director of the International Monetary Fund since 2011, is set to replace Mario Draghi, whose tenure at the ECB is likely to be remembered for his “whatever it takes” speech in July 2012, which led to a turnaround in the euro crisis.
If Lagarde’s nomination is approved, the political skills she has garnered at both the French finance ministry and the IMF could come in handy for a market rife with geopolitical concerns.
The last time I talked about Europe in this column I mentioned that 2018 had been very unkind to the continent, with sentiment hindered by economic data, trade tensions and Brexit. At the time, many of the region’s major economies were also flirting with recession.
Looking into the second half of 2019, things seem better: the market has improved – despite politics becoming ever more polarised and populist in nature – and H1 2019 saw the MSCI Europe ex UK rise almost 20 per cent in the year to 8 July (5 per cent more than the UK stockmarket), according to FE.
Changing ECB attitude
The changing attitude of the ECB has also benefited the market. In his latest speech, Draghi suggested the ECB would further loosen monetary policy unless it saw an improvement in economic data. This puts quantitative easing back on the radar given the bank still has enough headroom to purchase €1trn (£899bn)-worth of assets. The dovish tone could also indicate a rate drop is not an impossibility.
The fact is, however, that the market remains maligned, with one European fund manager I recently met up with calling it the “most hated market in the world”. It’s a tricky conundrum: reasonably cheap valuations and fair fundamentals are being undermined by geopolitics and trade tensions, with the latter hitting hard on the likes of the manufacturing sector particularly. Figures from the Investment Association show £4.3bn of net retail outflows from European equity sectors in the 12 months to May 2019, with £2.3bn in the past five months alone.
Scepticism is the buzzword, although some would say it is misplaced. For example, Schroder European Alpha Income manager James Sym cites the European consumer as a key driver of the market in the future, as it accounts for around 45-50 per cent of the economy.
Sym acknowledges that a slowdown is a worry, particularly as trade wars are such a concern given China is Europe’s biggest export market. He believes wage growth in Europe of around 3-4 per cent, coupled with benign inflation, is also bolstering the consumer’s pocket, while European governments are spending a bit more too to aid their respective economies.
As a result, he is targeting ‘unloved’ consumer cyclicals, such as car manufacturers, entertainment and retailers.
Reasonably cheap valuations and fair fundamentals are being undermined by geopolitics and trade tensions
He also believes banks are being overlooked in a low interest rate world.
Janus Henderson European Focus fund manager John Bennett believes the negative headlines around the market continue to suppress valuations and create opportunities to invest given the breadth of the region. Historically, Europe has been the vanguard for sectors such as science, design and luxury goods, and Bennett believes it will be again.
One of the key indicators investors must remember is that there are several global companies residing in Europe and their success is not exclusively tied to the likes of German growth or French politics. In fact, European equities now drive over half of their revenues and profits from outside Europe, with emerging markets accounting for around 35 per cent.
GAM Star Continental European Equity fund manager Niall Gallagher says the challenging economic data on Europe is not being reflected in the companies he and his team are seeing. He describes his colleagues’ view as “sanguine” and thinks the market is holding its own despite the difficult headlines we are seeing.
Europe is the perfect realm for active management in the current environment given one can either try and tap in to a number of overlooked sectors or stick with the strong global brands that are less reliant on underlying European fundamentals to drive their returns. As with the UK, a sensible Brexit deal would likely benefit valuations, as would further clarity on trade wars.
It’s a market that investors should consider if they do not have an allocation. However, with such strong political and economic headwinds, an experienced active manager would be a sensible choice to help mitigate the risks attached.
Darius McDermott is managing director of FundCalibre
Follow him on Twitter @DariusMcDermott