While we might view 2016 as a year when the unexpected became commonplace, it could well turn out that 2017 delivers just as many surprises – perhaps even more. Aside from how a Trump administration might change world trade and foreign policy, there are important elections taking place in the months ahead. Germany, France and the Netherlands will see their electorates heading for the polls, while the largely anticipated result of Italy’s referendum vote could yet precipitate a general election there.
The outcome of all these elections must be considered in doubt, particularly following the unexpected decisions reached in both the US and this country and given also the result of Italy’s constitutional referendum. It is clear an anti-political establishment move is underway which could yet undermine the way in which Europe is governed. While victory for Angela Merkel is expected in Germany and Marie Le Pen’s prospects in France look in doubt, it is worth reflecting that Brexit was a shock and Donald Trump was not expected to triumph.
So this year could prove pivotal for the European Union. Perhaps the most important vote is taking place in Germany. The chancellor’s policy of opening the nation’s doors to immigrants clearly has a strong body of opposition, given strength by atrocities such as that which took place in the Christmas market in Berlin. Yet Merkel’s stance is not entirely altruistic. Immigration can bring with it economic advantages. Arguably Germany’s industrial renaissance could not have taken place without the contribution of cheap Turkish labour. Turks continue to be an important component of the labour force there.
Germany is, of course, one of the greatest beneficiaries of the single currency experiment that introduced the euro, and any incoming Chancellor will doubtless recognise the considerable advantages that maintaining the status quo brings.
Similarly, a Le Pen victory in France need not result in the break-up of the European Union, though her antagonism to the single currency does add an extra dimension to the uncertainty that would result if she did become the next French president. And Italy must remain a concern for investors, if only because of the parlous state of its banking industry. This, the third-largest economy in the EU once the UK is taken out of the equation, faces both economic and social challenges that can only deepen if political upsets develop elsewhere.
Against such a background, choosing how to maintain exposure to this important economic area is far from easy. Ten months ago I reviewed the Investment Association’s Europe ex UK sector and came to the conclusion that the problems facing the EU nations were probably priced in, but that sufficient uncertainty existed to warrant continued caution. In the end the valuation argument clearly triumphed as markets recovered healthily, helped no doubt by robust markets elsewhere. Moving forward from here looks altogether trickier.
The rankings have changed remarkably little since February 2016, though the then dominant fund, Man GLG Continental European Growth, which led over all four timeframes reviewed, has seen recent performance suffer.
Over six months this fund has dropped to a fourth quartile 74 out of 100 (the Lipper tables list 107 funds in this sector, but only 100 have six month performance figures), returning a below average 11.6 per cent. Marlborough European Multi-Cap, on the other hand, has held up well and continues to sit in the top five throughout the tables.
Other managers, such as Aviva, Invesco Perpetual and Liontrust, continue to feature, while Jupiter has also seen shorter-term performance drop away, with its European fund close to the bottom of the tables over six months and one year. The message seems to be that some managers have failed to benefit from the risk on approach increasingly taken by investors as the year went on. Perhaps more difficult conditions later this year may see them return to favour.
There must be some risk that an absence of political upsets as the year progresses will encourage investors to throw caution to the wind, but I am concerned that potential problems, should voters continue to surprise us, are no longer priced in. Perhaps dumping existing exposure to Europe is a little extreme, but care must be needed, given the events that will unfold this year.
14.6% Average return in the IA Europe ex UK sector over six months
34.4% Return from the top-performing Marlborough European Multi-Cap fund over one year
88 Number of funds in the IA Europe ex UK sector over three years
164.3% Rise in the top-performing Man GLG Continental Growth fund over five years
European markets have recovered well in 2016, despite the number of issues that developed during the year. The results of the elections due in 2017 will have a significant impact on how Europe will be viewed by investors in the future. There are positives – Germany continues to flourish economically, for example – but sufficient uncertainty exists to suggest investors should take a cautious approach, at least until the political future of those important countries facing votes is determined.