Do the EU election results represent a significant change for European investors?
In our view, the EU election does not represent a significant change for European stock markets, particularly at the smaller end of the market cap scale. Despite the rise of potentially antagonistic populist voices in the EU, there is no clear desire for a break-up of the bloc, although the result may represent a risk of disruption to the traditional party system at a national level.
A bigger concern for us is the disappointment over the escalating tariff war between the US and China. Markets have gone from pricing in the expectation of a deal, to pricing in the expectation of no deal in less than a month. Investors are paying up for what they see as ‘low volatility’ stocks. We believe they are overpaying for safety, and overpaying for perceived structural growth as a thematic investment strategy. We are not convinced that this strategy is as risk averse as many would believe, and we believe that there are better alternatives, but that is a matter of opinion. In our view, investors have never paid so much for perceived low volatility, and we think that there is inherent risk in such a crowded market place.
Conversely, more economically sensitive (cyclical) stocks have priced in the risk of what we can only describe as a prolonged recession. In the short term, it is difficult to argue in favour of material improvements. But current prices may represent a good opportunity for longer-term investors.
Is the political impasse in the UK creating a decent value opportunity?
The UK is still an underweight for me and I cannot see any short-term reason for this to change. Contrary to many opinions, we do not believe that the UK is ‘unbelievably’ cheap, although we are interested in selected areas where we perceive the potential for structural growth, such as housing. We are reaching a point where ‘no deal’ is starting to be factored into pricing. We think that this is more likely after the EU election result and with a Conservative leadership contest ahead.
Were the Conservatives to elect a more right wing leader, it would indicate the likelihood of a lower tax rate regime in the UK. For the EU elite, perhaps the most controversial risk of Brexit is the possibility that the UK might – over time – become the ‘low tax/low regulation’ Singapore of the western world. Were the UK to be forced down the ‘no deal’ route, which now seems more likely than it did a few months ago, the UK may be faced with few alternative options.
Our view changes as we look across the Channel, where many European companies with UK exposure are, in our view, deeply undervalued. Similarly, anything with exposure to China has been sold off heavily, reflecting uncertainty over the US/China trade war. While this is understandable, exposure to China is not always bad.
How are you positioned in the European smaller caps market?
European smaller companies have always been geared to local growth factors, with exceptions. No matter the uncertainty in Paris or Berlin over the EU election result, there will always be positives at the margin. The entrepreneurial spirit persists in the EU. It is just a question of finding the stocks that are undervalued. They exist. For example, the computer gaming market in Sweden is interesting, while the Netherlands is emerging as a big beneficiary of Brexit uncertainty.
In this environment we remain strongly valuation aware in a market that is not, and continue to avoid paying up for potential growth. Ultimately, though, we remain in an environment of persistent lower growth. We prefer companies with lower debt, delivering a higher return on equity and have maintained a decent amount of dividend cover in our strategy, which provides some level of comfort in uncertain times.