Equity markets globally currently remain vulnerable to sharp shifts in sentiment caused by either unexpected or unwelcome outcomes in key upcoming political events (the US and German elections, Brexit and the Italian referendum). These top-down influences, combined with the current low global growth environment, will likely lead to broadly directionless markets, and prolong the current low beta return environment. We do, though, believe that attractive absolute returns remain possible in Europe. Investors will be required to work harder for returns, and differentiate their portfolios from the market as stock picking alpha becomes an increasingly vital component of ones, total return. We believe that earnings will be important to returns and any significant moves in European equity markets. Investors should focus on those companies which are able to deliver visible earnings from specific and attributable advantages. This contrasts markedly with the years immediately post the “Euro crisis” when it was sufficient to “buy the market”, due to exceptionally depressed market multiples.
We currently recognise many attractive bottom-up ideas in the European market, where companies, growth prospects are not necessarily tied to any cyclical recovery. Recent equity market volatility, which has been largely driven by top-down, short-term factors, has certainly created inefficiencies in the market, which we are looking to exploit through our disciplined long-term structural growth-oriented process.
“At a broader European market level, the earnings picture remains mixed, with Q2 earnings being better than many feared, and Europe finally beginning to see slight earnings upgrades.”
This though should be placed into the context of five years of negative earnings growth in Europe. Consensus European earnings growth for 2016 now stands at -1.7 per cent (down from +8 per cent in January), but many of these downgrades are attributed to a few sectors such as financials. For active managers, with differentiated stock selection, the picture is far less bleak.
The volatility, and crucially lack of earnings visibility provided at a European market level, differs greatly from the earnings profile of our strategies. Our holdings benefit from their visible, sustainable earnings growth, which is largely generated through company-specific factors, rather than through any dependence on the economic cycle. This ensures that our funds have consistently generated c.10-15 per cent earnings growth per annum through the cycle, with our earnings delta to the market, and thereby relative value, actually being widest during such periods of low global growth, such as we are currently witnessing.
There has recently been renewed debate surrounding the valuation gap between growth and value, which has undoubtedly reached wide levels. We do not feel uncomfortable with such wide valuation dispersion, which although wide by historical levels, reflects arguably a wider quality gap between quality/growth stocks and much of the value end of the market than in recent history. When we look at many of the “value sectors”, earnings visibility is increasingly weak with growing global economic/ political uncertainty (energy, mining), and facing significant structural challenges (banks).
We therefore do not see any reason for this valuation gap to change in the current low-growth environment, where companies able to demonstrate sustainable earnings growth will continue to command a valuation premium.
All sources Allianz Global Investors as at 15.09.2016.
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