John Bennett, Head of European Equities, explains why his outlook is the most cautious it has been in six years and what this means from a portfolio positioning standpoint.
How likely is a recession in Europe?
Growth is scarce – and in my view getting scarcer. I think we’ve already entered a global recession in a number of sectors and, more broadly, in international trade. One area we have been negative on for a long time is capital goods. A lengthy capital goods bear market appears likely in the western world, partly because of China. Where China was once a customer of European companies, it is increasingly turning into a competitor. As a result many a European manufacturer is likely to feel the force of Chinese competition moving up the value chain.
What are your expectations for interest rates globally?
We are, in my opinion, in a currency war on a global scale, with central banks using devaluations to increase competitiveness. The impact of this is evident in the euro versus the US dollar with Mario Draghi succeeding in his aim of supporting European manufacturing. Japan has followed suit but this has left Chinese manufacturers struggling to compete. Last year’s move to devalue the renminbi was a warning shot, but, in our view, one of the biggest threats to any investor in European equities this year is China. Were we to see a full blown devaluation, a serious recession on a global level may well be close behind.
In the US, talk of successive interest rate rises by the Federal Reserve (Fed) looks distinctly wide of the mark. In fact we suspect that the next move may actually be downwards.
What is your outlook for European equities?
My outlook is the most cautious it has been for six years. I have been saying for some time that we are in a bear market, one that had its roots in the spring of 2015 and which is now rolling through the market, from emerging markets and resources, through cyclicals and now ‘defensives’. Debt was at the heart of the crisis in 2008 and it has never gone away. Central banks have been doing their best to combat it, but they have created an environment of negative interest rates, which has actually encouraged more debt. The recent crisis in emerging markets is merely the latest domino in the global debt story.
Last year we cautioned that we were struggling to find value in European equity markets. Our view has not changed and we expect markets to fall further from here with a difficult January setting the tone. If they do (and losses in indices seem to be coming thick and fast) the good news is that the pain should be over quickly, with value coming back into the market, encouraging equity managers with long-term horizons to take a constructive view. However, it is hard to see European equities finishing the year in positive territory.
What can be done from a portfolio construction point of view against this backdrop?
I do not think buying an index will help anyone in 2016, as proved the case through January. In my view this will be a year for active investors, and at the moment our focus is on capital preservation. There are still a few potential bull markets, or bull industries, but 2016 is a year where we have to work hard to find the right opportunities.
One of these opportunities for us is cable telecoms. We have also dipped a toe into the energy sector after a long period away, adding positions in oil majors Total, BP and Royal Dutch Shell, for example. Oil prices, in our opinion, are starting to stabilise and, after significant share price underperformance, we believe there is scope for mean reversion.
On the flip side, we have reduced exposure to the European banking sector, based upon our concerns that other European countries may well follow the Scandinavian example of ever-harsher capital requirements. Our remaining banking exposure is focused on those firms with strong domestic franchises that we believe are capable of generating sustainable cash flows.
Are your portfolio themes still intact?
We have always invested based on core themes that should drive growth irrespective of the wider macro environment. These themes remain unchanged. We continue to see a boom in innovation, science and data, and should be well-placed to benefit from holdings in pharmaceuticals – a longstanding overweight in the strategy over the past six years. We remain optimistic about the prospects for auto component manufacturers (not, it is important to note, car manufacturers) which are benefiting from sustained demand for active safety technology to help make vehicles safer and more fuel efficient. We are also selectively investing in companies able to offer reliable growth and/or income – two in-demand scarcities in the market right now.