Panning for gold in murky waters

Panning for gold

In 2018, international investors pulled out more than €50 billion from European equities in response to weakening Eurozone economic data, uncertainty over Brexit and concerns about Italian banks. Today, investors’ positioning in Europe is as underweight as it has been since the Eurozone crisis.

It is understandable that investors are wary of a potential economic contraction. Europe’s inherent political and cultural complexities can further deter the cautiously minded. At a time when the US economy remains relatively robust and enthusiasm for emerging markets is gathering pace, many are choosing to put European equities into the ‘too difficult’ box.

But there are three primary reasons why investors choosing underweight positions in European equities are at risk of missing out.

 Loose connections

First, the correlation between European equity market performance and the region’s economic growth is lower than might be expected. Our analysis suggests that less than 25% of Eurozone equity market returns can be explained by Eurozone economic growth. And, in aggregate, under 50% of revenues for listed companies stem from the European Union.

When we look at individual sectors and companies, the linkages can be even lower. Sectors like healthcare, technology and consumer staples, where Europe has many global leaders, have very limited connections with domestic demand. Instead, they are benefiting from structural trends such as digitalisation, population ageing or the rise of the middle class in emerging markets.

Take Denmark’s Novo-Nordisk, world leader in diabetes treatment. Its financial performance is not driven by near-term economic data. Rather, the company’s fortunes hinge on the health crisis caused by long-term lifestyle trends.

 Hell or haven?

Second, for the seasoned and well-resourced stock picker, able to identify undervalued and overlooked opportunities, Europe’s apparent complexity is actually a great advantage.

It is perhaps unsurprising that, during times of economic uncertainty, investors find the European market particularly daunting. There are almost 20 countries in the benchmark. Many have their own language, each has its own cultures, laws, and labyrinthine political processes, creating further possible confusion. However, Europe remains one of the deepest and most liquid equity markets in the world and its economy is second only to China’s in size.

Europe remains one of the deepest and most liquid equity markets in the world and its economy is second only to China’s in size.

For experienced, bottom-up stock-pickers, the complexity that deters others provides a wealth of opportunities. Those prepared to look through the macroeconomic generalisations and search for non-consensus insights will find ample mispriced assets with potential for excess returns.

A good example of this is in Italy where, in recent years, we have uncovered several companies with apparently great potential. Hearing-aid retailer Amplifon has enjoyed robust growth. This is down to the company’s internationally diverse revenue base, favourable demographics, technology trends and consolidation of a very fragmented global industry. Amplifon’s prospects have very little to do with the Italian economy.

 Keep active!

Third, running focused, active portfolios gives the freedom to invest only in companies that offer compelling return potential. A concentrated portfolio has no need to own shares in the many hundreds of companies listed on the market. It can instead devote ‘firepower’ to a much smaller and more rewarding subset. Through careful stock-selection, active managers can achieve returns that are independent of the Eurozone economy and European equity markets more broadly.

In the current environment, a particular focus on those companies with robust business models, strong balance sheets and well-managed environmental, social and governance risks will be important.

The data suggests investors place too much weight on macro economics and political turbulence and too little on company-specific performance. That should change.


This article was previously published by Aberdeen Standard Investments on 25th March 2019