Despite the volatile start to the year due to uncertainty over the interest rate outlook, the econom...
Despite the volatile start to the year due to uncertainty over the interest rate outlook, the economic backdrop for European equities remains positive.
There were signs that GDP growth in several core European economies had started to accelerate during the second half of last year, with anticipated growth rates also picking up. Regional growth is benefiting from robust domestic demand and the improving export environment, as well as the upturn in the global economy.
Thus far there has been little evidence of any impact on inflation, as along with other western economies, deregulation, competition, excess capacity and technological change (such as e-commerce price transparency) are suppressing inflationary pres-sures.
While the pick-up in the oil price has heightened inflationary fears, there is little evidence of it feeding through to CPI as yet. Although the ECB has raised interest rates and financial markets are pricing in further increases, low structural inflation should guard against rates moving excessively higher and inflation should be below the official target.
European equity markets also look set to benefit from a variety of other factors. Continued deregulation is providing an ongoing stimulus, paving the way for cross-border mergers and the formation of strategic alliances, such as the recent Banco Santander/Societe Generale link-up.
Taxation reform is providing a boost, especially in Germany, where levels of corporate and personal taxation are being reduced. There is ongoing demand from pension funds, where the equity content is continuing to rise, as well as from private investors.
The latter are becoming increasingly involved in the equity market, both indirectly, through their participation in collective private pension schemes as well as through direct investment.
Continental Europe is undergoing a structural change as corporates realise the importance of cross-border expansion and that being a national champion is no longer enough.
Outsourcing is an investment theme which has taken root across a number of markets around the globe. It has become a key area of focus as an increasing number of companies hire external specialists to conduct peripheral activities. Another area which we believe offers significant growth potential includes leisure and media..
However, equity valuations have now risen to very high levels relative to bonds. This suggests that there is little room for earnings to disappoint, with those companies whose results fail to meet with expectations likely to come under considerable pressure. We therefore remain moderately cautious in the short to medium term and believe that a selective approach will hold the key to maximising returns.
Adrian Farthing is fund manager at Hill Samuel Asset Management
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