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Finding opportunity in Europe’s volatility

Looking back at 2018, it was a year when European corporate earnings continued to grow, while market volatility was surprisingly high. The volatility was a result of both political noise and the fear of a slowdown in global growth.

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Volatility first spiked in February and then in October 2018 as investors responded to fears about macroeconomic events. The more enduring and significant concerns were centred around China’s growth rate, the protracted Brexit negotiations and Italy’s controversial budget and these issues are unlikely to disappear in the short term.

But, rather than allowing political instability to distract us, we are concentrating on companies’ prospects. Going into 2019, this volatility has left stocks trading more cheaply than before and we anticipate them reporting earnings growth averaging 5-10%. At the same time, there are companies set to benefit from underlying positive long-term trends that we can buy more cheaply than before.

There is a lot of noise in the market at present and it is very easy to create a negative scenario, but we still expect positive economic and earnings growth. So, there are good opportunities for stock pickers.

Populism challenges the EU

In 2019, we anticipate that European economies will continue to recover, albeit slowly. Short-term risks still exist, which could result in slower growth. For example, Germany surprised by reporting negative GDP for the third quarter of 2018.

Political risk looks likely to persist during the year, but we are keeping calm and carrying on. We have modelled a range of Brexit scenarios. Of course, uncertainty remains; the process of the UK leaving the European Union is fluid and fast-moving. However, by carrying out an extensive risk analysis, we are putting our portfolios in the best possible position to weather a range of outcomes.

The EU is being challenged by populism on several fronts and is struggling to articulate what it stands for. However, the protracted and highly complicated process that Brexit has become may put off other nations contemplating a similar route and has shown how the EU can pull together if and when required.

Populism does not exist in a vacuum. Globalisation has generally benefitted the world, pulling millions out of poverty, however, it has not worked for all. Voters in the western world may have seen their industrial towns hollowed out as steel manufacturing or heavy industry has moved to cheaper emerging markets. These voters are becoming frustrated with their governments failing to address their concerns and are seeking more radical solutions. These structural paradigm shifts are not going to disappear any time soon.

Thematic opportunities

While globalisation may have challenged some economies, it has also created some exciting opportunities, both for society and for us as investors. The advent of new shareable technology is transforming the way people shop, work and live. It has never been so cheap to buy clothes or technology, and it has never been so easy to travel the world. Similarly, industrial processes are being changed by new materials or legislation around emission controls.

In finance, high street banks are being challenged by fintech disruptors. For example, thanks to a liberalisation of pension rules in the UK, there is a fast-growing DIY pensions market which did not exist just a few years ago. This creates some interesting prospects for investors. An array of increasingly flexible and user-friendly pension platforms is helping to meet new demand from savers and retirees.

’The smaller state’ is a related theme in our portfolio. With populations ageing across the western world, governments are struggling to meet their healthcare and pension commitments. However, new technology and service providers are creating efficiencies and companies that can help to bridge the gap left by pressured public health systems are often very attractive investment propositions.

Equally, we seek to avoid companies that face long-term challenges to their business models because of the changing nature of society. Some of the old rules don’t apply any more.

As we look ahead to 2019, there will undoubtedly be more short-term volatility but we are focusing on the long-term themes that are developing. The market is generally quite efficient, but inefficiencies often appear at times of dislocation and market volatility - we aim to take advantage of these moments and not allow the short-term noise to dominate.

Philip Dicken , January 2019

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