European Equity Market : Outlook 2016

Investors desperate for yield have been pushed up the risk curve and into equity markets. This demand has led to persistent upward pressure on share prices across the board without an equivalent rise in company earnings. Accommodative monetary policy has provided a welcome boost to equity markets, but a continuation of current trends will surely require stronger earnings growth. As European corporates have had many years to restructure and cut costs, any improvement in earnings will now, in most cases, have to come from sales growth.

In Europe, the economic environment has provided a favourable but fragile foundation for companies.

Purchasing Managers Index have hit recent highs, there has been moderate GDP growth, and leading indicators like credit growth and consumer confidence have continued to improve from a low base. Historical valuations look reasonable compared with those in other markets. Unlike in the US, earnings have yet to catch up with their 2007 peak. Taken in isolation, the outlook for Europe is good in my view. Unfortunately, Europe is not immune to what happens in the rest of the world.

Global economic growth continues to disappoint and emerging markets are looking particularly weak. The evolution of the Chinese economy from a high-growth, export-driven developing nation to one more dependent on internal consumption has not been – and will not be – easy.

The days of China making huge infrastructure investments with little thought given to the cost of capital may soon be numbered. This will weigh on many European companies, especially industrials and commodity-related businesses.

These risks are there for all to see. In recent years, investors in European equities have been favouring high-growth, high-yielding, defensive stocks. For instance, some sectors, like food & beverages have massively rerated, in some cases even as growth has slowed. This, in our view, means that stocks that would perhaps have been considered low risk in the past are now anything but.

As stock-pickers, we think the way to do well in this environment is to be selective. We aim to pay little or no premium to the market for a portfolio of companies with strong balance sheets and a proven track record of consistently delivering strong cash flows.

Nobody can predict what the future will hold, but we believe that by sticking with a process has served us well through a variety of different markets for more than a decade, we should be able to continue to add value for our clients.