We remain positive on the outlook for European equities and believe markets will continue to rally f...
We remain positive on the outlook for European equities and believe markets will continue to rally from here. This is because equity valuations are still reasonable in comparison with other asset classes and remain attractive by historical comparison. The recovery, however, will be gentle with growth rates of around 0.5% a quarter, but the economic cycle could last longer than it has done in the past.
Since inflation has only increased slightly, we believe interest rates - in particular short-term interest rates - can continue to remain low for a longer period. This could prolong the economic cycle. Developments in the bond markets are also important. Yields from long-term loans have increased slightly, causing a steepening of the yield curve, which has led to a confident assessment of the cyclical market segments that are benefiting from the change.
The outlook for the global economy has also improved, which should have positive implications for Europe. The Federal Reserve has made it clear it will not raise US interest rates until there are unambiguous signs of a strong recovery in the US economy. Given this backdrop and the liquidity being pumped into the system, at some stage companies should start to report strong earnings growth.
In view of the prolonged cost- cutting most companies have undertaken over the past three years, any improvement in top-line growth will flow straight through to the bottom line. This is also true for companies in Europe. Moreover, analysts will be too pessimistic about the recovery, just as they were too cautious when it came to cutting their estimates in the downturn. Prolonged low interest rates have also enabled several highly-indebted companies to escape the risk of bankruptcy. In view of the increased scope for them to re-finance their debts, it is possible for the value of the equity to increase quite rapidly. This is why our funds have recently been buying a lot of recovery stories.
While Europe is lagging behind the major economies in terms of economic growth this year, there have been some positive signs recently, particularly in Germany, Europe's largest economy. The IFO indicator has risen for four straight months and the government has been surprisingly determined in its efforts to push through structural reforms. These include significant cost savings in the health budget, the reform of the pension system (the proposed increase in the pensionable age from 60 to 67 is dramatic), extended store opening hours and changes to unemployment benefits. Moreover, the unions are on the defensive. Germany is an export-led economy and will inevitably benefit from any pick-up in business spending.
Over recent months, we have become more encouraged by the prospects for Germany, particularly in light of the structural reforms now taking place. Although we do not look primarily at geographical weightings, valuations in Germany had reached very low levels as analysts had become too pessimistic.
Many German companies are benefiting from pent-up demand in Eastern Europe (GDP growth in the countries due to join the EU next year is around 5% pa). Many German companies have also shifted their manufacturing bases to these countries, to take advantage of lower operating costs. German companies not only benefit from lower labour costs but also from important tax benefits - Estonia, for example, has no corporate tax at all.
A similar picture exists in the Netherlands. There are plenty of companies that overextended themselves during the boom years, and consequently there are now lots of restructuring stories. While it is true the economy is still in poor state, again, valuations are extremely interesting.
Based on our more optimistic view of how the economy will continue to develop, we are overweight in the more cyclical sectors. These include industrial consumer and cyclical services. In addition we are underweight in the more defensive sectors. Targeted selection of individual securities in conjunction with extensive research remains vitally important in order to filter out the best companies.
Apart from cyclical securities, we are also favouring companies that are restructuring and are misunderstood by the market after a two or three-year bear market. Analysis is concentrating in particular on companies whose quality is generally held in low regard by the market. We are filtering out the companies,which we believe no longer show signs of low quality, but are quite simply good value. Examples of such companies include EADS, Swiss Life and ABB.
Two global vehicles
'Further plug advice gap'
Must appoint separate CEOs and boards
Advisers do come out well
Will report to Mark Till