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European Equities: Selectivity is key in 2019

15 January 2019

Niall Gallagher, investment director at GAM Investments, is optimistic that 2019 will open up an array of interesting opportunities for investors, given 2018 was a challenging year for European equities.

It was a tough 2018 for European equities and investors in our space had to navigate a challenging landscape for a number of reasons:

  • European growth concerns. There were signs of slower growth over the course of 2018, even though most economies on the continent were still expanding at or above trend levels towards the end of the year. We have observed that while many economists have cut their growth expectations for 2019, it is generally from ‘above trend’ to ‘at trend’ and therefore believe fears about a growth slowdown may have been over played.
  • Factor trends. It is increasingly apparent, in our view, that machine / algorithmically-driven investment activities and those aligned to factor risks are having an increasingly marked impact on equity movements over the short-term (as transpired in the second half of 2018). While these factor-driven moves can be painful, we feel that increased factor trading and dynamic risk management to factor models by fundamental investors is creating greater market inefficiency and therefore may lead to very interesting opportunities for long-term investors.
  • China. There are two aspects to this issue: first, that US-China trade tensions could lead to a decline in global economic activity with knock on impacts for Europe; secondly, that China and emerging markets more broadly are increasingly important to the earnings of European companies with circa 50% of the revenues of European companies now derived from outside of developed Europe and over one third coming from emerging markets. There were some signs that the Chinese economy decelerated towards the end of 2018, with a contraction in business confidence and consumer durable goods such as autos, therefore we believe it would not be irrational to link this to the negative moves in sectors like European autos.
  • Geopolitical concerns. In particular, concerns over populist governments in a number of European countries such as Italy, Hungary and the UK (Brexit) engaging in erratic and potentially harmful economic policies. We find political gyrations the hardest factor to quantify into any kind of analytical structure other than assuming that they tend to raise the cost of equity for the country concerned as well as dampening general sentiment.
  • Quantitative Easing (QE) to Quantitative Tightening (QT). This shift in central bank policy is very hard to map out through any kind of transmission mechanism from central bank balance sheet adjustments to equity market variations, but we believe it has been a prevalent impact on sentiment and has therefore impacted our valuation expectations in certain parts of the market – for example we found technology to be slightly rich in the early parts of 2018.

Despite these concerns, going into 2019 we believe European stock valuations, dividend yield and corporate earnings look attractive. While macroeconomic and political headwinds could weigh on earnings potential next year, we still believe European companies should be able to post stable profit growth. European stocks have lagged the US market since the global financial crisis and we think a ‘catch-up’ trade with US equities is likely to take place and largely be earnings driven. Underlying earnings growth in Europe is now at 8-10% per year and we expect this to continue.

In our view, the growth in middle class consumption in global emerging markets should remain a key theme for investors in European equities, given the ongoing strength of the region’s consumer, luxury brands. LVMH Moet Hennessy Louis Vuitton SE, the world’s leading luxury products group, reported a 10% increase in revenue at the group level in the first nine months of 2018. The fashion and leather division (which includes Louis Vuitton), exceeded expectations with growth of 14% on the back of strong luxury numbers in Asia and the US. LVMH who has invested in building a physical presence in China has benefited from the breadth of their wide-ranging portfolio including leather goods, jewellery, wines and spirits and travel retail which appeal strongly to millennials who have a strong desire to own luxury products.

Other potential opportunities could stem from sectors such as automobiles and construction, which are currently at very subdued levels and consequently we believe there is considerable room to the upside.

2018 emphasised the need for sharp stock selectivity in order to maximise the opportunities available in European equities and we believe 2019 will be similar. Not all areas of the market will benefit from the positive trends we anticipate and exposure to European equities through broader passive approaches could expose investors to many of the unattractive areas of the market.

Given the range of possible outcomes, it is clear, in our view, that an unusually high degree of selectivity is required by European equity investors in 2019 in order to reap benefits.

Important legal information
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice.
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