While the trading costs typical of a low-liquidity environment can reinforce inertia, these can be overridden if macroeconomic signals inspire renewed optimism and conviction among investors. With western economies picking up slightly, is the PM’s glass half full or half empty?
So what are the macroeconomic dynamics that are directing the performance of European equities?
With many European countries – Greece, Spain, Italy, Ireland to name a few – having to bear the brunt of imposed austerity measures, consumer spending is likely to decline for some time to come. This will lead to a regression in economic growth in these nations, damaging corporate earnings. A prolonged age of austerity could be self-reinforcing as stubborn debt levels are tackled by ever-stricter measures by governments, which could deal further blows to consumer confidence.
This means earnings growth – and therefore the value of equities – will remain stagnant, even if there is a favourable market environment.
“Equities have come a long way from their 2009 lows and volatility is at low levels. [But] we need economic growth to stabilise and earnings to begin to improve for the market rally to be sustained,” wrote Paul Doyle, head of Europe ex-UK equities at Threadneedle Asset Management, in a Viewpoint note published earlier this month.
Will problems in countries outside of Europe affect growth in the region?
Doyle cited the possibility that the slowdown of growth in China – the response to which has been delayed by a change in political leadership in the country – could be worse than expected.
“Emerging economies are an increasingly important engine of growth for Europe and any slowdown among these markets, or in the US, would be unhelpful,” he said.
Optimists will hope that US Q3 GDP growth of 2% is a sign of better times to come, especially as it has been accompanied by a 1% uptick in UK GDP growth.
On the other hand, the actions required to reduce the US budget deficit (known popularly as ‘the fiscal cliff’) are widely expected to slash government spending and eliminate tax breaks. According to the Congressional Budget Office, these measures could lead to GDP decline of around 4%, sending the US economy back into recession.
So where might my portfolio manager be looking for new sources of alpha?
Emerging markets have been constantly trumpeted as a source of outperformance since the financial crisis. Growth in China and India may be sluggish at present and opportunities for outperformance are all but tapped out in countries like Brazil, but there may be opportunities much closer to home.
“The outlook for emerging Europe on a stand-alone basis is positive. Valuations are attractive, trading on around 6.5x price-earnings ratio, a 60% discount to their global emerging market peers,” noted Allan Conway, head of global emerging market equities at Schroder Investment Management. “Government, corporate and household balance sheets and their fiscal position are generally strong, especially when compared to the developed world. On a country basis we are finding Turkey attractive but also countries such as Egypt, Kazakhstan and Georgia remain compelling for stock-specific reasons.”
Further afield, domestic demand among Southeast Asian nations is driving sustained economic growth in the region.
“ASEAN economies have successfully restructured and deleveraged since the 1997 Asian financial crisis and are firmly on the investor radar including, significantly, foreign direct investors who are allocating resources and capital,” notes SooHai Lim, manager of Barings ASEAN frontiers fund. “This in turn is creating jobs, resulting in a re-rating of property prices in both industrial and residential sectors.”
Sounds like there are still few reasons for institutions to dive into European equities.
It’s important to not disregard European equities altogether. If earnings growth were to pick up, good quality cyclical European stocks – such as car manufacturers, airlines, hotels or restaurants – would be good prospects.
While remaining cautious about the growth prospects of the vast majority of European stocks, Doyle said: “We believe that there are opportunities on valuation grounds, both among those stocks that have been oversold, and in businesses operating in particular niches, which are relatively immune from the weak economic backdrop.”