EU sceptics forced to acknowledge recovery in region they don’t understand


European sceptics are being forced to acknowledge the recovery in a region that they have failed to understand politically, as the eurozone enjoys positive PMIs and employment figures while rejecting populist politics, investors say.

April saw the fifth largest allocation shift from US to European equities since the start of the eurozone in 1999, a recent survey from Bank of America Merrill Lynch Fund Manager Survey revealed.

The Shiller ratio for the region is still trading at a 36 per cent to the US, while many domestically-focussed European companies are trading at 50 per cent-plus discount.

The aftermath of the French election has created a sweet spot, according to Witold Bahrke, senior macro strategist at Nordea Asset Management, of reduced political tail risks, strong economic fundamentals and relatively easy central bank policy.

Europe is currently 3 per cent cheaper than its long term median price-to-book, while the US is 10 per cent more expensive, Bahrke says.

However, Bahrke warns there is divergence between countries and sectors.

“While generally a good environment for European equities, late cycle dynamics also result in higher macro uncertainty, potentially increasing the divergence between sectors as well as countries.”

Stuart Mitchell, manager of the SWMC European fund argues investors who view the EU as a trade agreement only have underestimated European support for the project.

We have always held the view that the European project rests on stronger foundations than many believe.

“For most Europeans, the European Union is seen as something much more than a mere trade agreement; rather, it is seen as a way of bringing together countries which have warred with each other for centuries.

“For many, it is a single voice that can negotiate in all fields of political life with a strong America, China and Russia. It is also seen as a guardian of liberal values.

“The election cycle following Brexit has amply supported our analysis. While some argued that Brexit would lead to the immediate collapse of the eurozone, the reality has proved very different.

“Even the most sceptical observers now acknowledge that the European economy is truly recovering.”

Sector allocation

Dean Tenerelli, portfolio manager of the T Rowe Price Continental European Equity fund, says they are finding opportunities in defensive areas of the market, such as telecoms, their largest overweight, and regulated utilities.

“We believe valuations do not reflect improving industry fundamentals – based on the explosive growth of mobile service data and online video, which is boosting high-speed broadband penetration.

“There is a continuing desire for M&A that improves both market structure and drives fixed-mobile convergence.”

Mike Clements, head of European equities at SYZ Asset Management, says they are finding opportunities in three areas of the market: infrastructure; areas impacted by political uncertainty, particularly around Brexit; and healthcare.

“As a sector, healthcare stocks generally meet our quality criteria, but they are currently too expensive to warrant a large position in the portfolio.

“However, it is possible that President Donald Trump’s reform of Obamacare and his focus on cutting US drug prices puts pressure on the sector.”

Martin Todd, European Equities Portfolio Manager at Hermes Investment Management says European corporates had a strong Q1, with almost a quarter of companies in MSCI Europe beating estimates by 5 per cent or more.

“Technology permeates every stock and sector to some extent, whether it is retailers enhancing online sales channels, banks overhauling legacy IT systems or telco’s protecting themselves from cyber threats.”

Todd points to Madrid-based Amadeus, an IT solutions provider to the travel industry.

“Its Altea software is enabling airlines, hoteliers and others to manage capacity, inventory and pricing more effectively. This provides a boost both to top-line revenue and reduces operating costs.”