Q1 2018 Portfolio Discussion: Investing in Europe
While Europe is growing strongly, company earnings are coming off of a low base and have plenty of room to rise as the economic recovery continues. We do not expect a recession in Europe and, if political risks continue to subside, investors could start to focus more on the improving economic and corporate fundamentals.
The European economy is recovering, with recession risk low
- Unemployment in Europe is falling, but given it is still high, there is still plenty of room for the jobless rate to fall further. As falling unemployment is both a sign of corporate optimism and supportive of consumer spending, unemployment continuing to fall should support both the economy and markets.
- Retail sales and industrial production are also recovering, showing that the recovery is broad based.
- Business sentiment surveys suggest that growth should remain healthy.
Guide to the Markets - UK, page 16
Room for recovery in European earnings
- Companies had struggled to grow earnings since 2011, thanks to a combination of slow growth and little corporate pricing power.
- Economic recovery should normally be expected to lead to an improvement in earnings growth. For years, earnings expectations for Europe have started the year high and then been downgraded throughout the year. In 2017, however, earnings expectations were not revised down.
- It is not only expectations that are improving - actual delivered earnings are growing as well and the growth is broad based across most sectors.
Guide to the Markets - UK, page 39
The end of European equity underperformance?
- Earnings growth really matters for the performance of European equities. A stronger euro does not mean that European earnings cannot grow strongly, as shown by the period prior to the 2008 financial crisis.
- Margins in Europe are depressed but are starting to rise as stronger nominal growth boosts sales and operating leverage amplifies that into even stronger earnings growth. As European margins are coming off of a low base, they should be able to rise further.
- Some investors fear they are too late to the party in European equities, but flow data suggests that not all of the money that came out of European equities is yet to return.
Guide to the Markets - UK, page 38
- European equities could benefit from continued economic recovery feeding through into corporate earnings growth.
- The European Central Bank has noted that “political winds are becoming tailwinds.” If concerns around the Italian election in March prove to be overdone, as they were in France, this could provide a boost for European equities given the improving economic backdrop.
- A stronger euro does not necessarily prevent European companies’ earnings from growing.
Our unconstrained Europe Dynamic (ex-UK) Fund invests in attractive value, quality and momentum stocks, which have driven long-term stock market returns.
This is one of the few investment trusts to focus on the European smaller companies market – allowing investors to share in the growth potential of an exciting asset class through a disciplined investment strategy managed by an experienced and longstanding team.
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