Lessons learned from 2017?
TS: The lessons from 2017 have been patience, in the sense that, at last, the economic recovery has started to come through in Europe. We have also had greater political stability in Europe; the UK and the US have been the exceptions. Europe has been more rational. Crucially, for the markets, has been the fact that the earnings growth has actually started to come through.
JR: Another observation we’ve made is that 2017 has really been a year when investors have been willing to price in disruption, probably faster than ever before, and you’ve benefitted from owning the disruptor rather than the disrupted. You’ve seen this across a number of different industries, the most obvious starting point being Amazon as a disruptor, and anything it touches as the disrupted. More recently you’ve seen Amazon enter the food retail space and the impact this has had on European food retail companies.
When looking at electronic vehicles and their increasing penetration in the auto space, you’ve seen huge disruptive forces. So who have been the beneficiaries? Umicore, a battery technology provider and Continental, a company we have a position in who provide car parts and will definitely benefit from selling parts to a car that is electronically powered, rather than one that is powered by a combustible engine.
Key themes for European markets in 2018 and portfolio positioning implications?
TS: I think we should see a continuation of the economic recovery in Europe, excluding the UK. The UK is beginning to see issues related to the uncertainty caused by Brexit. So European economies should continue to grow, and we expect earnings to continue to grow as well. I suspect that we will start off with around about a 10% estimate for earnings growth in 2018, which is obviously encouraging. But backed up with this, we’ve got to be prepared for the fact that the European Central Bank (ECB) will continue its trend towards tapering quantitative easing.
The big debate at the end of 2017 and entering into 2018 will be whether inflation is going to start coming back into the system. If it does, questions remain as to where 10-year government bonds will be trading, what impact this will have on the equity markets, and when the European Central Bank (ECB) will start to tighten interest rates. Our expectation is that there won’t be an increase in interest rates until well into 2019.
JR: Unfortunately, I think we have to talk to politics as well. 2017 has been a year when we have seen quite a big improvement in the political outlook for the whole European region. However, it would be naïve to think that that is the end of political risk. This is certainly the case when looking at the recent events in Catalonia which show that political risk remains and has a direct impact on markets, equities and valuations.
The two things running into 2018 that we would be concerned about would be Brexit and Italy. In the Uk, we are seeing a near implosion of the government at the moment, with Brexit negotiations that can only be described as stagnant and sluggish at best. This is something that concerns us. We have been underweight UK domestics for a number of years and became even more underweight immediately post the Brexit referendum, a stance that we still feel is right.
Italy would be the second thing to consider, although it’s difficult to say what is going to happen there. We know that there is an election coming up in a very fragmented political landscape, where it is not entirely clear who is going to win that election. It is also not entirely clear whether the winner of that election will be someone who is anti-EU or pro-EU, and whether they will have the support of the people.
Key risks and opportunities for 2018?
TS: This goes back to when you look forward for where the key opportunities are for 2018. It helps to look in the rear-view mirror. There are a lot of long-term investments which have performed very well in 2017. Some of the technology related names such as Amadeus and Infineon have been performing very strongly, and we would expect that to continue into 2018 when looking at the business. Another longstanding holding, Deutsche Post, has done exceptionally well for the last couple of years and is becoming an enabler. Deutsche Post is helping people to deliver products, making progress in their particular businesses. These types of stocks should continue to make progress in spite of the fact that they have already performed reasonably well and therefore their valuations are higher than when we established positions some years ago.
JR: We’ve talked about the savings theme for a number of years. Globally, and certainly across European markets, the onus of saving is moving from the government to the individual. We try to take advantage of this by owning providers of retail savings product. The challenge is that those providers of retail savings products, which are largely fund management type businesses, are seeing fee pressures across the board. Consequently, you are not only after a provider of those services, but after a low-cost provider of those services.
JR: James Ross
TS: Tim Stevenson
These are the managers’ views at the time of writing. References made to sectors or asset classes do not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase them.
Disruption/disruptors: Disruptors are invasive, innovative and often fast-moving companies focused on the development of new technologies, products or services that are cheaper or better than existing options. They can have a significantly disruptive impact on the operations, structure and competitive environment for existing businesses.
Inflation: The rate at which the prices of goods and services are rising in an economy.
Quantitative easing: A measure whereby a central bank creates large sums of money to purchase government bonds or other securities, in order to stimulate the economy.
Underweight: Where a strategy has less exposure to any particular company, sector or area of the market (including countries), than its peers, or a relevant benchmark or index.