With Article 50 now triggered and the formal Brexit process underway, the world’s eyes will remain on Europe for the foreseeable future. Here, Michelle McGrade, Chief Investment Officer of TD Direct Investing, discusses for Finance Monthly the investment opportunities on the horizon and the relevance of the socio-political environment that surrounds businesses.
The UK’s vote to leave the EU last June was likely to catalyse political uncertainty across Europe. This was especially true with a number of Eurozone countries, including the Netherlands, France and Germany, holding elections over the course of 2017. With Donald Trump’s unexpected election victory in the US, concerns around the rise of populist governments gaining power in Europe have been further raised.
The result of Dutch election recently, in which the populist measures proposed by the Party for Freedom (PVV) lost out to the current People’s Party for Freedom and Democracy (VVD) government, was a positive outcome for European markets looking for stability. The risk of a potential exit from the European Union (EU) and the euro, as well as further restrictions on immigration, have all receded.
But, what does this mean for investors?
According to our most recent customer survey, 65% of respondents believe Europe has been wounded by the rise in the populist movement. But when asked whether a populist movement – in this case triggering Article 50 – will have a positive impact on their portfolios, investors were split; 38% were unsure while only 32% thought it would.
While the Dutch result suggests this risk might be over-inflated, the uncertainty will persist until the outcomes of these elections are known.
We need to stop being blinkered by the politics
When the Dutch election vote came through I said publically that instead of focusing on politics, we should probably concern ourselves more with the fundamentals. Ian Ormiston, fund manager of Old Mutual Europe (ex UK) Smaller Companies, agrees. He believes there are reasons to be positive on the outlook for European equities and agrees that we should largely ignore politics. “Investing in European equities is not the same as investing in Europe,” he says. “Next time you are tempted to talk politics, opinion polls, and the vagaries of the US Electoral College system, try restraining yourself, however tempting. No one knows how key political events are going to transpire, just as no one knows what the stock market’s reaction to those events is likely to be. As investors, let’s try to stick to the knitting and focus on company fundamentals.”
The cyclical recovery across Europe is showing signs of gaining momentum. Lead indicators remain positive and there are signs of improving confidence from companies and consumers. Eurozone unemployment is also continuing to fall, supporting the recovery seen by consumers. This is being aided by easier borrowing conditions for both corporates and households, helped by a European banking system which is finally becoming better capitalised and willing to lend. The threat of deflation is also abating, with inflation approaching the European Central Bank’s (ECB) target of 2%.
So, where are the European fund opportunities?
John Bennett, head of European equities at Henderson Global Investors and manager of Henderson European Selected Opportunities, points to a meaningful move away from growth and towards value investing. He is particularly keen on European banks.
“While it is early days, the signs are good that this change in leadership [from growth to value] could be durable,” says Bennett. “Such a shift, should it continue, favours Europe, home to many ‘value’ stocks, and is positive for the kind of stocks and sectors that investors have found easy to avoid for much of the last decade.”
“Our tilt to value accelerated significantly in the second half of 2016,” he continues. “That acceleration was writ large by our move into European banks despite, like many other investors, finding the sector still very easy to dislike. History shows that investing in European banks would have been a spectacularly wrong call from 2008 until recently, but we feel a combination of vastly improved capital ratios and a turning point in interest rate expectations has made the industry once again investable.”
In addition to these funds you could also tap into opportunities in European equities via BlackRock Continental European Income, which seeks to generate income by investing in companies with a strong competitive position and earnings stability, and with sustainable and growing dividends, or Jupiter European Special Situations, which invests in high quality companies whose profits are growing.
For European equities, the strengthening economic backdrop is improving earnings prospects. Following several years of moderate or no growth, expectations are for high single digit earnings growth this year, with further improvement in 2018.
Europe now turns its attention towards France and its upcoming presidential election. Should Marine Le Pen’s Front National win there could be consequences for the EU, but the two-stage electoral system in France could act against her. Nevertheless, investors are likely to remain cautious until the political risk across Europe reduces.
What we’ve learnt from Brexit is that no one knows how key political events are going to turn out, and what the stock markets’ reaction to those events will be. As investors, it is better to stick to what you do know and focus on a long-term investment horizon.