The arrival of capital flows into European equities coincided with the reduction of political risk in the Old Continent after the first round of French presidential elections. But with the German and Italian elections on the horizon, the question is whether the fundamentals will continue to support the upturn. Fiona English, client portfolio manager at Pioneer Investments, talks with Funds Society about het outlook for European Equities.
Europe has received a big amount of inflows in the last quarter, but is it sustainable? Are the fundamentals supporting this performance?
Indeed flows coincided with the reduction in political risk following Round 1 of the French presidential Election as investors believe the chances of fragmentation within the Eurozone has subsided. That said, in reality there are 4 main drivers of European Equities which combined suggest that the performance of the European market can continue– 1) better economic growth, 2) better earnings growth 3) reduced political risk and 4)flows into the asset class
We are experiencing quite synchronized global growth at this moment and with 50% of earnings for European companies lying outside the Eurozone, this clearly provides a support to earnings potential for European companies. Within this, European GDP Growth is likely to strengthen this year with our Economists forecasting 1.8% for FY 2017. The key here is for companies to translate the more supportive economic backdrop into earnings growth and we are witnessing signs of this. In Q1 on aggregate, 46% of companies beat consensus estimates by 5% or more, while just 22% missed, pointing to the strongest quarter since the Q2 2007.
This and the reduction in political risk within the Eurozone has given investors the confidence they needed to return to the asset class with 18bn of inflows in the last 2 months alone.
In our view, for the market trajectory to be sustainable – we need to see confirmation of earnings growth continuing as we move through Q2 and Q3 this year.
Have investors lost the train in European equities after the rally seen in April and May?
While the rally was swift, we still believe there is more to go if earnings growth proves sustainable. The asset class remains underowned with many international investors now beginning to consider European equities “investable” again.
In fact despite the rally, European Equities have seen a slight reversal of this trend since mid-May with the market moving sidewards at best and underperforming the US market. There is probably an element of seasonality at play and the market is likely seeking another catalyst to move higher from here. We believe this will come in the form of a confirmation of further earnings growth. Any further weakness may provide a good buying opportunity as we move into the second half of the year.
Where are you finding the most attractive opportunities and what areas are you avoiding?
Given we believe that earnings growth will be the dominant driver of returns from here and in line with our investment process, we believe the most consistent way to generate performance will be through good stock selection. We do not believe that earnings growth will happen across the market as a whole but rather you must look for the companies which have a strategic competitive advantage and the ability to capitalize on better economic trends and convert it into better earnings growth. In this environment, stock selection will be key to performance.
How have you positioned your portfolio to take advantage from the rally?
We have looked to keep quite balanced portfolios not favouring any one area of the market but looking for idiosyncratic/stock stories which we believe have the potential to deliver medium term outperformance. For example, most of our portfolios are overweight Industrials at this moment due to the number of individual compelling investment cases we find there. The sector offers a number of different business models which will benefit from the more positive macroeconomic tone but also strong companies which have a strategic advantage that allows them to translate this into earnings growth. Finally valuation is clearly always important and we look to seek the correct entry point which should allow us upside potential from a valuation standpoint.
Is it the right moment to invest in more risky assets within equity or should we be more cautious?
The key for the equity market is to see greater earnings growth – if this happens we believe the market can move higher.
Do small-caps look attractive versus large-caps?
We see opportunities in all areas of the market. Finding value should be less focused on market capitalization but more on individual companies and their ability to deliver.