John Bennett, Head of European Equities, explains why he believes Europe could be the catch up trade of the coming months. While John highlights a number of risks to this view, he points to how out of favour Europe has become and the potential for the region to outperform some of this year’s ‘in fashion’ asset classes. John also questions whether a shift in inflation expectations will lead to a change in market leadership and potentially the renaissance of value stocks.
What is your outlook for the European equity market?
Our business is fashion – and there are victims of fashion. I say that because over a number of years I’ve watched Europe usually come into favour at the wrong time among international asset allocators, and go out of favour at the wrong time. I think we’re now at a point where Europe is easy to dislike again. It’s never easy to love as a region for well-publicised reasons. We see that from the flow data; investors have got themselves well invested in, for example, emerging markets, but Europe is out of favour. My outlook is therefore that there is a good opportunity for catch-up. It requires one major thing – for markets to hold their nerve in October, which is usually a tricky time. We have an election coming up in the ‘lead’ US market, which is also an expensive market. If the US market holds in the coming three months or so, I think Europe has got a good chance of outperforming, as it is so disliked.
Which areas are likely to be the main beneficiaries?
I think that’s a key question, and I think we’re at an important moment regarding market leadership. It’s dangerous to forecast market direction, but we’re always asked to do it. Since the crisis of 2008, as a European equity investor, you’ve just had to buy growth stocks. That’s with perfect hindsight, but it’s been a wonderful growth stock market – not just in Europe, Japan is similar. Forever collapsing bond yields have helped that dynamic. For the first time since then, questions are being raised over growth stocks outperforming value. I think if we are to see an inflexion in that leadership, I think we have to see a change in inflation expectations. I think we’ve got a good chance of seeing that coming. It might not happen – it’s happening right now in the UK – but it might not happen in Europe. But the chances are quite high, and this will have meaningful repercussions for market leadership. It may well be that we are coming to the end of the growth market boom verses value stocks.
How are your portfolios likely to fare in these conditions?
I don’t like style investing. I’m too neurotic to be camped at one side of the boat. I’ve never wanted to say to a client ‘I’m really sorry about the last five years’ performance, but I’m just a value manager’ when growth was in. So I live my life thinking what’s in fashion now could be out tomorrow. I’ve never been an out-and-out growth or value manager. Although, I tend to be a more value conscious person because I love cash flow, care about balance sheets, and I’m stingy – I don’t like to pay a high P/E. But it’s been correct to pay a high P/E in the last seven or eight years for growth stocks. So I’ll never be camped entirely on one side of the boat. In the last 12 months, having been tilted to the quality growth side, since September 2015 we’ve gradually been tilting back to what people might call value. We began buying oil a year ago, and recently we’ve been tip-toeing into banks. What does that mean? We don’t lurch to one side of the boat – we’re in the middle because we’re not sure. It might not be an inflexion, but I do think the chances are growing that we’re going to see a change in style leadership.
What are the main risks?
In pure market direction terms, if the US raises interest rates and the market doesn’t like it and falls, say 10%, then Europe isn’t going up. Europe is quite a high beta play on the US, especially on the way down. That would be the near-term risk to direction. The other is the Chinese renminbi devaluation, which is ongoing and not getting enough air time. If that comes back to centre page, that could be a risk to market direction.
The risk to Europe experiencing a change in market leadership is bond yields going to new lows ie. the deflation argument keeps winning. That would knock on the head any renaissance of value, which is why I’m in the middle of the boat – I think we’ve reached the low in bond yields, but I can’t be sure.