European equities – interesting times
“There is a Chinese curse which says ‘May he live in interesting times.’ Like it or not, we live in interesting times.” This Robert F. Kennedy quote from 1966 sums up what it has been like to be a European equity investor since the UK voted to leave the European Union in June 2016.
While politicians have yet to deliver Brexit, one impact of the surprise result is the perception of heightened political risk in Europe. This is the view shared by both European and international investors. Partly as a result of this, we have seen significant outflows from European equities. According to EPFR, an industry leader in flow data, global investors withdrew over $80 billion from European bourses in 2018. Mounting concerns about Italy’s budget, as well as fraught and chaotic Brexit negotiations, drove the exodus.
At the recent European elections, right-wing and populist parties made strong gains at the polls. This came at the expense of traditional centrists groups. These parties, such as Italy’s League, have the European Union and euro in their sights. However, despite the political rhetoric, we have yet to see any concrete policies that would fundamentally alter the attractiveness of Europe as a stock-pickers’ market.
Looking beyond the headline returns, high-quality companies that are growing their earnings and cashflows are significantly outperforming. This compares to the underperformance of those businesses with low absolute valuation metrics (i.e. value stocks).
During times of uncertainty, it is logical to invest in companies that have a strong competitive advantage, or “economic moat,” as legendary investor Warren Buffet called it. This ‘moat’ helps protect the company and, by extension, investors against unexpected events. It also means a company can raise prices when needed without losing customers. This pricing power is particularly important during times of large currency moves. Take the pound versus major international currencies following the Brexit vote. At that time, the fall in sterling made overseas components more expensive for UK manufacturers. Many suffered. By contrast, companies that could raise prices to compensate without losing customers had a competitive advantage. They were also rightly prized by investors.
Despite the political noise, Europe is a strong hunting ground for stock-pickers.
Despite the political noise, Europe is a strong hunting ground for stock-pickers. It is large, highly liquid and has the complexity of multiple countries, cultures and legal systems. For active investors, this creates compelling — and often mispriced — opportunities across sectors that exchange-traded funds might miss. Powerful structural drivers also underpin the future growth of high-quality companies. These include demographic changes, the digitization of industries and the enduring value of premium brands. We believe such businesses should continue to thrive – even in interesting times.
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.