James Sym (pictured), equities fund manager at Schroders, considers European value stocks in a rising inflation context for the eurozone.
After the fireworks and aggressive falls of the first two months of 2016, March saw a stabilisation with the benchmark up 4.1% over the month and 13% from the February lows.
The broad European market at the low of February was down 27% from the cycle peak in 2015 with plenty of stocks having halved. Picking over the detritus of the market collapse leaves us more excited than we have been for some time as we perceive increasingly interesting opportunities to put money to work.
Aside from the very important valuation arguments for a subset of the European market; our positivity is also illustrated by looking at the overall trajectory for earnings.
Because of the lack of growth, earning revisions have been far more important this cycle than valuation (so far, this may change) so looking at the earnings trajectory is instructive. Since the beginning of the year analysts have downgraded the market earnings by about 9% and are forecasting a gain of just 6% over the next year.
The point is expectations are reasonable, even conservative.
With inflation likely to pick up (this is a very important statement by the way), conservative profit expectations, and rising PMIs suggesting a recession this year is unlikely, we would encourage investors once again to consider having some exposure to European value stocks, where typically we could see 50%-100% upside on a 3 year view.
Although some progress has been made, in too many ways Europe has squandered the opportunity of the last 3 years.
With exceptions, structural reform in aggregate in the periphery and France has been too slow, the core countries have not lifted their consumption enough to close financial imbalances and an obsession with austerity has seen a lack of growth.
As a consequence, partly driven by electorates and partly by financial markets, we are seeing cracks emerge again in the European project. As such we do not want to have an excessively cyclical or operationally geared portfolio today.
However it is clear that defensive and growth areas of the market are expensive on a relative basis. Their momentum will inevitably wane at some point. Equally overall economic growth in 2016 will benefit from some residual stimulus from the fall in commodities and accommodative monetary policy.
On this basis we advocate a portfolio with a value bias – ideally without heading too far down the quality curve to achieve this.
Investors underexposed to value risk significant underperformance when the current trends mean revert as they are likely to, and we do not want to fall into this camp. As discussed a more positive inflationary outcome would likely catalyse this mean reversion.