European equities: volatility equals value opportunities

01/03/2016

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​Nick Sheridan, manager of the Euroland strategies, explains why recent market volatility and uncertainty is to be welcomed for the long-term opportunities it presents. With pricing correlations between assets beginning to break down, Nick sees a pick-up in attractive opportunities based on fundamental corporate analysis.

What are your thoughts on recent market volatility?

Many commentators have speculated that not only have global quantitative easing (QE) measures inflated asset prices, but also served to dampen volatility across all financial assets. If the start of 2016 is anything to go by, it looks like the decision by the US Federal Reserve to start normalising interest rates had the opposite effect, depressing markets and increasing volatility.

It would be very easy to write recent market falls off to experience and focus on the positives for Euroland assets: the potential benefits of the European Central Bank’s accommodative monetary policies; relatively low valuation levels compared to other developed markets; the potential for a long-overdue recovery in corporate profit margins in the region; and the attractive income yields on European stocks.

Unfortunately, being an optimist in markets potentially carries a very high price. Thus, to my mind, it is always worth looking at the problems and trying to strike some sort of balance. Euroland equities have re-rated against broadly stagnant earnings in recent years, so any threat to a widely anticipated recovery in company profit margins would be problematic. However, just as Europe seems to be on more solid footing for a sustained (albeit protracted) recovery, China seems to be slowing quite quickly.

One solution to kick-start growth in the world’s second largest economy would be to devalue the renminbi; however, should this happen, any European recovery would end. Given China is a ‘command’ economy, the market cannot dictate the level of the renminbi and any move will ultimately be politically driven. In addition to this, the US remains in something of a quandary. Many companies have used the opportunity afforded by historically low interest rates to swap equity for debt. ‘Normalising’ interest rates could therefore cause problems for US Federal Reserve chair Janet Yellen.

Against this backdrop we expect volatility to remain at elevated levels for the time being. While this is bad for investor sentiment generally, it provides an environment in which we typically find some of our best long term opportunities.

Have you changed your positioning as a result of market moves?

For investment managers considering a longer-term horizon, market uncertainty should be seen as an opportunity, rather than something to be feared. As shareholders get nervous, pricing correlations across assets begin to break down. This can create attractive mispriced prospects for active managers focused on corporate fundamentals, such as ourselves.

A good example of this is car manufacturer Renault, which came under selling pressure at the start of 2016. Market uncertainty combined with news that Renault – as with all other car manufacturers in France – was undergoing testing on its engines, following the issues with Volkswagen last year. We were convinced that this report would turn out to be something of a damp squib, and indeed that was the case. It did, however, provide an opportunity to add to our holding at attractive levels.

What are your expectations for Euroland equities?

Politics aside, notably the Brexit negotiations, the Euroland region seems relatively well supported. Exchange rates and the current low oil prices (which while deflationary are good for both consumers and businesses) remain a tailwind, while purchasing managers indices still point to slow expansion. Monetary policy is likely to remain very stimulative in Europe, while bank lending is improving, which should support internal spending within the Euroland area and possibly lead to higher capital expenditure for companies.

While we are sanguine about the economic backdrop in the Euroland, probably the biggest potential impediment to our expectations is the risk of external shocks, namely a slowdown or currency devaluation in China, or US market weakness caused by earnings contraction as the cost of borrowing bites. It is important to keep in mind that investment in any one region can never be isolated from another, and short-term market moves, if not politically inspired, are normally correlated. On the other hand, long-term shareholder returns are generated by profits made on a firm’s underlying assets and in this sense Euroland seems to be recovering.

Aside from the economy, one of the long-term metrics I use to gauge value in the market is the Shiller P/E ratio, a valuation measure applied to broad equity indices that measures earnings per share over a 10-year period. Currently, as shown below, the Shiller P/E rating remains significantly discounted versus its long-term median, suggesting above-average returns for investors within the single currency area over the longer term.

Shiller P/E indicates a significant discount on eurozone equities

Shiller P/E (x)Long-term median P/E (x)Discount, %
Italy11.925.553%
Portugal8.514.140%
Spain11.619.039%
Japan25.641.238%
Eurozone13.520.534%
France16.422.728%
UK13.118.127%
World20.923.310%
Germany18.219.88%
Switzerland21.921.42% premium
US24.722.88% premium

Source: JP Morgan, as at 5 January 2016

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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Anything non-factual in nature is an opinion of the author(s), and opinions are meant as an illustration of broader themes, are not an indication of trading intent, and are subject to change at any time due to changes in market or economic conditions. It is not intended to indicate or imply that any illustration/example mentioned is now or was ever held in any portfolio. No forecasts can be guaranteed and there is no guarantee that the information supplied is complete or timely, nor are there any warranties with regard to the results obtained from its us.


Important information

Please read the following important information regarding funds related to this article.

Janus Henderson Horizon Euroland Fund

Specific risks

  • Shares can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.

Risk rating

Janus Henderson Horizon Pan European Alpha Fund

Specific risks

  • Shares can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • Changes in currency exchange rates may cause the value of your investment and any income from it to rise or fall.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.

Risk rating

Janus Henderson Horizon Pan European Equity Fund

Specific risks

  • Shares can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • Changes in currency exchange rates may cause the value of your investment and any income from it to rise or fall.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.

Risk rating

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