European investors are currently under pressure on two fronts. Firstly euro zone interest rates are ...
European investors are currently under pressure on two fronts. Firstly euro zone interest rates are not only likely to rise significantly higher in order to suppress growing inflationary pressures, but the rises will almost certainly extend further into the future than those in the UK and the US.
Secondly, the economic situation in the US is proving to be a difficult conundrum for European investors, with the question as to whether the US economy will have a soft or a hard landing having a significant bearing on European investment decisions.
Our European portfolios maintain a slight defensive growth bias because of this lack of market direction and investor nervousness. We are underweight in the telecom sector because of the pressure on earnings being exerted at the moment by growing competition. We favour pharmaceuticals due to their defensive characteristics and earnings growth potential. European financials also offer good value at current valuations.
However, as an investment region, Continental Europe has extremely attractive long term potential. European corporate earnings are being upgraded while in the US downgrades are expected.
This makes European valuations more attractive than those in the US, and as relative economic growth and interest rate differences narrow, the euro is likely to appreciate. This will encourage overseas purchase of euro denominated financial assets. Economic restructuring, such as fiscal and labour market reform, operates at the macroeconomic level. These changes are offering tangible results to investors. In July, for example, Germany reformed its tax system, with the result that the tax burden on German companies will be reduced.
Some changes, such as a reduction in corporation tax, will benefit every industry. Other changes, particularly in industrial and labour policy, will benefit some sectors more than others. For instance, reducing the non-wage cost of temporary and part time labour will help the leisure sector more than it will help water utilities.
The competitive pressure on European companies has increased dramatically over the last decade. As a consequence, the amount of corporate activity taking place in Europe is accelerating. As the old inefficiencies disappear, whether in the form of opaque corporate ownership or government meddling via an industrial policy, so greater opportunities for European investors emerge.
We favour a broadly style-neutral approach with only slight biases regarding cyclical/defensive factors that depend on the macroeconomic environment. Greater precedence to bottom up stock selection is being given as this approach focuses on individual companies' ability to benefit from the most powerful single reason for investing in the European region: restructuring.
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