Cinderella before the ball

European equities crashed out of favor with investors in the last year with the longest run of persistent outflows in a decade. For 2018, net outflows from active European equities funds totaled €44 billion with another €14 billion in the first two months of this year. (Source: Broadridge, for Europe-domiciled funds). 

European market participants were battered by disappointing economic news in 2018 with a deterioration in the macro picture especially pronounced recently. They shared worries about a general global slowdown and US-China trade wars but also region specific problems like the “Yellow Jacket” protests in France and UK and Italy political uncertainty. 

However, our Chief Economist believes that domestic demand drivers remain supportive of a 2019 GDP growth of about 1.5% for the Euro area. Declining unemployment (six-year lows), rising real income, positive consumer confidence and very accommodative financing conditions all point to a stabilisation. The latest prints for PMI and Consumer Confidence (March 2019) indicate a rebound from 2018 year end lows. Growth may have slowed, but it has not fallen off a cliff.
 

Even after the rally year-to-date, investors can access European equities at five-year low valuations following the market drawdown in 2018. 

European equity valuations are especially attractive compared to U.S. equities on measures such as price to book. Currently US stocks are trading at a P/B of 1.3x more than European stocks (3.0x compared to 1.7x).

We view the negative international sentiment for European equities as an excellent contrarian buying opportunity; the growth scare has led to an unwarranted discount. Lost among the macro headlines is the fact that Europe is home to many of the world’s leading businesses. While they may not generate fervor like Amazon or Apple, companies within our portfolios like Louis Vuitton Moët Hennessey, ASML and Prudential are world-class companies in their own right. 

Our managers’ expertise is in identifying high-quality companies and to purchase them at attractive valuations to deliver strong returns in the medium to long term. They are bottoms-up stock pickers but they use to their advantage fear or negative sentiment in the market.  Though more economically sensitive sectors and stocks are currently unloved, they are the ones that, when chosen correctly, have the ability to outperform the most in an eventual rebound. 

Thus the investment team is investigating areas of the market such as the energy, auto and tech hardware sectors whose valuations imply we are in a mild recession. Yet the US economy is performing well, the eurozone continues to expand (albeit more slowly than at the start of 2018) and China is injecting stimulus.

However we can not deny there is market uncertainty and unease. But we believe that our managers’ selective stock-picking approach is optimal in such conditions. This means that the best companies may be purchased when everyone else sees rags while our managers know that they will be transformed into ball gowns.