In the second-part of his look at top European equity managers’ tactics, Rob Griffin hears about optimism over earnings and the potential shocks that lie in store.
Franz Weis, a fund manager for European equities at Comgest, says the future is as difficult to predict as ever but as long as companies deliver the results expected from them, the stock market could edge up further over the next few months.
‘As the year progresses, investors will start looking at the likely earnings dynamics in 2018, wondering if earnings growth can continue to be as strong as in 2017,’ he says.
More dynamic economic growth will certainly help, he says, but the UK could be an exception while its Brexit talks continue.
‘Considering substantial contributions to this year’s earnings growth came from the famously unpredictable financials and raw materials sectors, uncertainty is understandably high,’ Weis he says.
Looking beyond 2017, he sees the level of uncertainty for stock markets increasing. ‘International politics, raw material prices and the speed of economic growth are difficult to predict, but may have a strong impact on many companies’ sales and profitability,’ he says.
In addition, he warns that monetary policy, which has been extremely lax and supportive to valuation levels, will necessarily start tightening again at some point. ‘We won’t take any view on potential future macro trends or events,’ he says. ‘Instead we continue to focus on quality growth companies.’
The key to success, he says, is to select companies that can grow sustainably by investing in product innovation or geographic expansion, as well as those leading the pack in market niches.
These niches benefit from structural growth drivers such as an ageing population, digitalisation, the need for companies to raise productivity, or a strengthening middle class.
‘We remain invested in companies such as Inditex, Wirecard, Amadeus and Essilor, and expect them to continue delivering dynamic growth,’ he says.
Capitalising on recovery
‘We remain positive on macro prospects for the eurozone, assuming roughly 1.5% GDP growth for the area,’ he says. ‘We always focus on mid-caps that deliver double-digit earnings growth, in comparison to large-caps with mostly low single-digits.’
Furet says the priority when it comes to investing in this region, however, has been avoiding underperforming thematics. In 2014 and 2015, these included oil industry suppliers, telecoms companies and utilities.
‘Another key to success has been choosing companies that were able to capture the eurozone recovery as far back as 2012. These mid-caps have represented at least 50% of the fund over the last three years,’ he says.
As far as current themes are concerned, Furet highlights growing digitalisation, as well as automotives, construction and financials.
Carl Auffret, AAA-rated manager of DNCA Invest Europe Growth, agrees there are plenty of attractive opportunities in the region. He cites Shire Pharmaceuticals, which has historically provided treatments for ADHD, as a favoured stock.
‘Its rare disease treatments may lead to pricing power, patient loyalty and limited biosimilar risk,’ he says. ‘The launch of Xiidra, a dry eye treatment, has the potential for $1-2 billion of revenues.’
Another stock he likes is Ryanair. He believes this company and fierce rival EasyJet will eventually have a 50% market share in Continental Europe, up from 20% today.
‘It has excellent fundamentals: European-only exposure, record profitability, no financial debt and a very high cash flow.’
Ken Hsia, + rated manager of the Investec European Equity fund, hasn’t taken his eye off potential threats and says the key risk to European equities is an economic shock or slowdown as the market relies on earnings growth to underpin company valuations.
Hsia says that following a period of re-rating amid scarce yield, rising rates could gradually pressure valuations in some defensive sectors.
‘We continue to seek out pockets of earnings growth as it’s important to remember that as well as the household mega-cap names, Europe is home to many innovative companies in positions of strength in their market niches,’ he says.
He also remains constructive on the outlook for European large-caps. ‘The improving earnings trajectory seen in Europe since the start of this year is becoming entrenched, helped by industrial demand, signs of improving employment and consumer spending in southern European countries,’ he says.
Cyclical recovery in sectors such as construction is still in the early stages across Europe, in comparison to historical activity levels, so Hsia sees room for further earnings improvement.
Elsewhere, constraints on capex in recent years mean that pricing power is emerging in some sub-sectors where demand is exceeding supply, such as speciality chemicals.
‘The gradual move towards a normalisation of interest rates creates a tailwind for the financials sector, particularly the more rate-sensitive banks,’ he says.
These comments originally appeared in a supplement published with the September edition of Citywire Selector magazine.