With gaps in food shelves, an energy crisis and rising inflation, it has been hard to look away from UK news in recent weeks. But those who have also kept an eye on our Continental neighbours will realise that the political landscape in Europe is being dramatically reshaped.
The departure of Angela Merkel, after 16 years at the helm in Germany, is inevitably causing uncertainty and it is still not clear who will lead the coalition that will govern the country. Negotiations could take months.
Meanwhile, France is also gearing up for Presidential elections next year.
Political turmoil: President Macron faces elections in France next year while Angela Merkel remains a caretaker leader in Germany
‘Politics looms ever large in the Eurozone,’ says Jason Hollands, managing director at wealth platform Tilney. ‘However, it’s important not to overstate the influence of politics on investment markets and there are good reasons to see opportunities in European equities despite the uncertainties that elections bring.’
WHY THE TIDE IS JUST STARTING TO TURN
One reason why investment experts see such opportunities is that Europe as a whole has underperformed over the past year.
Many companies suffered during the pandemic as consumers reined in their spending during lockdown. Yet, while their profits are now improving, these financial numbers are not fully reflected in their share prices.
Tracy Zhao, senior fund analyst at wealth platform Interactive Investor, points out that the STOXX600 index of leading European companies has climbed 16 per cent this year. This is lower than the equivalent 20 per cent increase in the value of the leading US companies, as measured by the S&P500 index.
Given the momentum of the economic recovery in Europe, Zhao believes there is merit in the region’s stock markets.
But not all companies are enjoying the recovery to the same extent. Darius McDermott, managing director of independent broker Chelsea Financial Services, says this gives fund managers opportunities to search out those companies that will benefit the most.
‘While Europe has its issues, it is home to some world-class companies that deliver year in, year out,’ he says. ‘There are also thousands of smaller companies across the continent, so there are a wealth of equity opportunities that are under-researched and not covered by many analysts. That means good managers can really add value.’
SO WHERE DO THE OPPORTUNITIES LIE?
John Bennett, co-manager of the Henderson European Focus Trust, is among those investment experts who believe there are opportunities to be found in Europe.
He is adding to his investment in value stocks within the region. These are companies that appear reasonably priced, rather than those such as tech firms that have seen rapid share price growth, particularly during the pandemic. Bennett is finding these opportunities in several unloved sectors.
‘The most striking feature of markets both sides of the Atlantic since early summer has been the stark underperformance of the value style versus growth,’ he says.
‘Our exposure to oil, banks and automobile companies has risen – via stocks such as Lundin Energy, Total, Daimler, Stellantis and BNP Paribas.’
James Carthew, who runs investment research group QuotedData, says that in bumpy European markets, those who are successful at picking European stocks have done well and will continue to do so.
‘These have been stock-pickers’ markets and not every manager has managed to navigate this successfully. Three-year figures give a good indicator of who is doing well,’ he says.
FUNDS GIVE YOU A WIDER EXPOSURE
While you can invest in European stocks directly on a wealth platform, one of the safest ways to invest in the region is through a diversified fund. This means that you are not overly exposed to the fates of just a few companies, but are invested in a number – in a variety of sectors and countries.
You can invest through a low-cost tracker fund to get exposure to a broad range of European companies. Such funds include Invesco STOXX Europe 600 and Vanguard FTSE Dev Europe ex UK. Both of these are exchange traded funds and their shares are listed on the London Stock Exchange.
But if you prefer the skill of a fund manager to handpick companies in the region, there are several good European active funds that may fit the bill. Zhao likes Man GLG Continental European Growth which has returned 59 per cent over three years. The fund invests in a number of companies set to benefit as consumer spending picks up post pandemic.
‘A quarter of the fund’s portfolio is invested in consumer-cyclical stocks which should do well as economies recover,’ says Zhao. ‘In the mid to long term, it provides investors with the prospect of capital appreciation and a well-managed downside risk compared to many peers.’
Both Zhao and Hollands rate Liontrust Sustainable Future European Growth, which has returned 59 per cent over three years.
‘The fund has 20 per cent exposure to the German market,’ Zhao says. ‘This means it may suffer short-term price volatility due to protracted coalition negotiations.’
Yet she points out that the fund has a good track record in producing strong returns by investing in companies that achieve resilient growth and are sustainably managed.
Hollands describes the fund as a ‘top pick’ for investors who want to target companies which improve the quality of people’s lives – whether through environmental efficiency, medical advances, or other positive social impacts.
For those looking to invest in smaller European companies, James Carthew at QuotedData recommends Montanaro European Smaller Companies, which is up 134 per cent over three years. ‘Fund manager George Cooke’s focus on quality and growth helped the fund lead the performance tables through the pandemic, but it does not seem to have led to any faltering of returns in the recovery phase,’ he says.
For larger companies, Carthew recommends investment trust BlackRock Greater Europe, up 113 per cent over three years. The secret of the trust’s success, he says, is a focus on companies whose growth is sustainable.
McDermott likes Marlborough European Multi-Cap and Comgest Growth Europe ex UK, which are among the top ten performers in the European fund universe over the past three years.
‘The Marlborough fund has a bias towards small and mid-caps and has a truly exceptional track record,’ he says. It is up 89 per cent over three years.
‘The Comgest fund is more concentrated in quality growth companies and is also extremely well run and consistent,’ he adds. This fund is up 67 per cent over three years.
POSITIVE OUTLOOK AS COMPANY EARNINGS RISE
Carthew urges caution for those with a short-term outlook, pointing out that the German post- election talks ‘will be making some investors uneasy’.
‘Markets hate uncertainty,’ he says. ‘It may be that investors are in for a bumpy ride over the next couple of months. However, uncertainty has been the norm for some time now.’
He adds that he believes those funds that have done well for the last few months should continue to thrive.
It is not just wrangling over who runs Germany that will affect the European market in the long term. The fuel crisis, as well as Covid19, will continue to affect company valuations.
But there are some good reasons to be optimistic about how things will play out. Chris Beauchamp, chief market analyst at investment trading platform IG, says the ‘outlook still looks bright for European markets overall, fuelled by improving company earnings’.
GERMANS MAY ISSUE BONDS
While a coalition government is rare in the UK, the Germans seldom have anything else.
The complex electoral system means that although elections were held late last month, with the centre-Left Social Democrats (SDP) claiming a narrow victory, it is still far from clear what the direction of travel will be.
Parties must now attempt to form a coalition – and it may not be the Social Democrats who are successful, as all parties are free to attempt to make coalition deals. Due to the spread of votes this time, any coalition will contain three or more parties. Until it is decided, Angela Merkel remains as a caretaker leader. She won’t be able to make new laws, but she can keep the government running.
Darius McDermott, of Chelsea Financial Services, says that it is hard to see now what the impact of a new German leadership will be.
Instead, the markets will move when it becomes clear who ends up in the coalition and their likely impact on economic policy.
‘A lot will depend on whether the SDP can push through their initiatives,’ says McDermott.
‘For example, they think fiscal austerity is wrong in the post-Covid environment, so they could seek to increase spending.
‘That could mean more German bond issues and downward pressure on bond yields.’
Investors shouldn’t hold their breath for clarity.
In 2017, the post-election process took six months to sort out, while Germany’s European neighbours can take longer.
The Netherlands is yet to conclude negotiations after its elections in March, while in 2010 it took Belgium 541 days to form a government.
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