Europe's animal spirits have returned, with our experts taking an increasingly positive view of the continent's equities.
Despite fears about a stock market correction that’s yet to materialise, Jim Levi says most of our panellists are fairly confident about Europe’s prospects. Unfortunatly, the same can't be said about the UK.
World stock markets continue to climb the proverbial wall of worry, with no sign yet of a serious hiccup in prices. A regular survey of 180 global fund managers by Bank of America Merrill Lynch in June revealed 44 per cent of them thought global equities were overvalued. Such warning signs are not being ignored by our panel of asset allocators: far from it.
Three months ago Rob Burdett of F&C Investments was pushing up his cash position with a score of 8, ready for a setback in equity prices. ‘In every one of the last 10 years we have had at least a 10 per cent setback in the FTSE All-Share index,’ he points out. ‘We are overdue for such a correction because we have not had one since January 2016.’
Well, the correction has not happened yet – leaving Burdett looking wrong-footed, at least in the short term. Richard Dunbar at Standard Life Aberdeen Asset Management says: ‘People are worrying about the next market downturn, and because they are worrying it is not happening.’
Burdett agrees that before that elusive setback materialises markets may have to become more exuberant. ‘Equities are not cheap by any means, but we are not in the “blow out” territory that often signals the end of a bull market,’ he adds.
The US has led the global recovery and is likely to be at the forefront of any market downturn. According to Burdett, some of the technology stocks are ‘showing signs of getting frothy’. Keith Wade at Schroders argues that the strength of US equities has been concentrated on technology stocks such as Amazon, Apple and Alphabet (Google).
He also admits: ‘We are now probably a bit less exposed to equities than we were three months ago, as funds have been switched into global government bonds and corporate bonds.’ Other panellists seem to be keeping their powder fairly dry, although there is still a general move away from US equities into Europe (ex-UK), Japan and emerging market equities.
Unusually, Alan Higgins of Coutts has decided to leave all his scores unchanged. ‘At the very margin I am less bullish because markets have gone higher, but not enough to downgrade any of my scores,’ he says. All the panel members have kept their US equities scores unchanged from three months ago and are now either neutral or underweight.
Higgins insists his US score of 4 ‘does not signal we are selling out of the US, but is more a signal that we can do better in Europe, Japan and emerging markets.’ In terms of valuations these markets are much cheaper than the US. But, equally, Higgins believes it is ‘very unlikely’ other equity markets can go higher without the US going up.
He admits that it is hard to find value in US markets. ‘But that is where you find the quality growth companies with low or zero debt that have done so well. The problem, as always, is that if you want quality you have to pay for it, but you have to avoid paying too much.’
Europe on the up
European equities are very much in favour with the panel. Chris Wyllie has joined the rest in going overweight by raising his score from 4 to 6. ‘We bought back in ahead of the French election result,’ he says. Certainly the arrival of Emmanuel Macron instead of Marine Le Pen at the Elysee Palace has scattered fears of a collapse of the European Union and revived ‘animal spirits’ across the European business community.
Wade has also lifted his European equities score here from 6 to 7. ‘The notion among some Brexiteers that the EU would disintegrate following the UK’s departure looks increasingly implausible,’ Wade says. ‘Indeed we in Britain seem to be the ones falling apart.’ Meanwhile, the euro has strengthened, while Wade notes that capital ‘has been flying into European equities’ from the US.
‘Europe is where we see the greatest potential for corporate earnings growth,’ he adds. Similarly, all the economic data on Europe is looking good – in contrast to the US and UK economies, which are showing signs of slowing down.‘European exporters, particularly Germany, are benefiting from a pick-up in global trade,’ says Higgins.
The German and French stock markets are around one third higher over the past year and since the beginning of 2017 both markets are up around 8 per cent. As Dunbar says: ‘Although there is a very strong case for European shares, the market has already performed well.’ So he leaves his score unchanged at 6.
Market worries about political change in Europe seem to be evaporating. With Macron seeing off Le Pen in France, Burdett seems confident Angela Merkel will retain power in the upcoming German elections. ‘Even if she does not, the alternative is still likely to be pro-European and helpful to the stock market,’ Burdett says.
Like the rest of the panel he has gone overweight – raising his score from 5 to 6. As Macron tries to reform French labour laws, Burdett warns tourists to ‘look out for the tractors blocking French motorways this summer’. That might well prove an appropriate opportunity to buy French shares.
Mixed Signals on UK Equities
There are mixed signals from the panel on the prospects for UK equities. Three panellists are now underweight the sector and the average score for home-grown shares has slipped to a new low of 4.4. With the economy showing signs of slowing and consumer spending on the decline, Chris Wyllie warns that ‘some of the Brexit chickens are now coming home to roost’.
He lowers his UK score from 4 to 3. Like many of us, Rob Burdett believes negotiations with Brussels are almost bound to prove protracted and painful. ‘The plain fact is there are 18 member countries who are net recipients from the EU budget, and nine net contributors,’ he points out.
‘The UK is the tenth contributor and one of the most significant. So if you want an agreement with all 27 you have either to persuade 18 of them to take a pay cut or nine of them to increase their contributions. That sounds to me like turkeys voting for Christmas.’
Like Wyllie, Burdett’s score is down from 4 to 3. Even Alan Higgins, the most bullish panel member on UK shares, acknowledges the risks. ‘If you look at recent political events there can be a short-term negative effect. This is enough to make business more cautious, which will slow the economy.’
However, although he admits there are already ‘some signs of softness’ in the UK’s performance, he does not see a recession on the horizon. Defiantly, Higgins keeps his UK score at 7. He has support from Richard Dunbar, who swims against the tide and raises his UK score from 4 to 5.
While Rob Burdett and Chris Wyllie fret over the possible consequences of the Brexit talks, Dunbar keeps his cool. ‘By buying the FTSE 100 you are not really taking a strong view on a good, bad or indifferent outcome from the Brexit talks. You are saying many international companies in the FTSE 100 will benefit from the positive global growth outlook.’
All the bearish noises about the UK have not prevented the market itself from performing quite well. The FTSE 100 has doubled since the market’s recovery began at the beginning of 2009, and over the past year has gained in excess of 10 per cent, having hit an all time peak in early May. That, says Keith Wade, is a good enough reason to move in the opposite direction to Richard Dunbar and lower his score from 5 to 4. ‘Brexit has led to a weaker pound and higher inflation and we do think the domestic economy is going to be quite weak.’
The rest of the world
Enthusiasm for Japanese shares is now more muted, though all the panellists bar one are overweight. But Wyllie has lowered his score from 7 to 6, moving some funds out of Japan and into Europe. He follows Wade and Higgins, who both nudged their scores lower back in May.
Burdett is still Japan’s biggest fan, with his score staying at 8.The emphasis of his investments there has switched now to Japanese domestic stocks rather than the big exporters. ‘Growth stocks focused on the local market are far outstripping the main indices,’ he says.
There have been no changes in the panel’s scores on emerging markets equities. All are overweight and the sector still retains the highest average score of 7. ‘As with Europe, we see emerging markets as the area where we find the greatest potential for companies to raise their earnings,’ says Wade.
One of the more intriguing features of financial markets has been the way government bonds have been amazingly well supported despite the miniscule returns on offer.
Until now the panel members have remained underweight in both global bonds and UK bonds. But Wade has now raised his global bonds score to a neutral 5. He explains: ‘I feel the global economy has reached a cruising altitude and it does not look like it is going to accelerate any further. I suspect we are moving back to stagflation, where real incomes are not rising on the back of lower unemployment levels. Stagflation means a low-interest rate, low-growth and low-inflation environment.'
Dunbar agrees the support for government bonds reflects ‘the absence of core inflation and some doubts about the general global growth prospects, particularly in the US. For some time bond yields have been perceived as being low, but that has not prevented them from being driven even lower.’
Higgins believes UK investors buy global bonds as a currency trade to protect themselves against a falling pound. ‘But we still think sterling is due for a recovery and that is one reason why we keep our global bond score at just 2,’ he says.
The endless hunt for decent yields has brought high-yield corporate bonds back into favour. Dunbar is the only panellist bearish on this sector with a score of 3. Meanwhile, Wade has raised his score on the asset from 5 to 7.
Wade’s ‘stagflation’ fears have prompted him to cut his score for the property sector down from 5 to 3. ‘There is a clear link between the performance of the whole economy and commercial property rents,’ he says. ‘The buoyant property market really only applies in London, particularly with the pound having weakened. But we think elsewhere property companies might now struggle to maintain rent levels.’
For the panel as a whole, interest in the property sector has subsided in the past 18 months. Only 18 months ago, property, alongside European equities, was the most highly rated sector. Now only Higgins has an overweight position here.
Weaker oil prices have left commodity prices lower and this year Thomson Reuters Core Commodities index has slumped from near-peak levels of 195 in January to a 12-month low of 166.5. Recent weakness in oil prices has been a major factor behind the fall. Despite this weakness, the panel are now all neutral or overweight commodities, with Dunbar raising his score from 4 to 5. They clearly expect a recovery in oil and possibly gold.
‘Given the turmoil on the political front recently, the price of gold has been remarkably quiet,’ says Dunbar. ‘The oil price is 20 per cent below its April levels and there have been similar falls in industrial metals and soft commodities. So, having underperformed, a neutral stance on the sector seems more appropriate.’
In precious metals, Wyllie remains keen on gold, which he sees as ‘a much better diversifier than government bonds’. He is also positive on the black stuff , as he maintains that ‘oil is due for a rally’.