Standard Life Investments

Published Article

Unconstrained investing strategy captures opportunities in European equity


 

Once again we have had an eventful summer in markets. It is always useful on these occasions to pause and reflect on what is happening and what of substance is changing. This is a growth scare.

The sharp Chinese stock market move down and subsequent policy action has raised fears for Chinese growth. This has then raised doubts on the expected rise in US interest rates later this year. This has then raised questions on both continued Euro weakness and European economic recovery. The impact on the European market has been a setback of around 10% despite a reasonable results season with few shocks as the market has quickly concluded that these results have been more about the past than the future. The advance of the market in the last two years has been driven by a rerating anticipating earnings recovery. Concerns on growth now question that earnings recovery but for now the market is 10% cheaper than a month ago.

Low interest rates stimulate corporate activity In Europe interest rates will not increase for some time. Monetary policy with or without further Euro softening is expected to remain loose and supportive for the market. The oil price has almost halved driven as much by new supply as weak demand and we still have to see the benefit of that for consumers and corporate earnings. Low interest rates will stimulate corporate activity such as the interest from Swiss insurer ZFS in the UK group RSA. Lower valuations will support this trend.

Low interest rates stimulate corporate activity In Europe interest rates will not increase for some time. Monetary policy with or without further Euro softening is expected to remain loose and supportive for the market. The oil price has almost halved driven as much by new supply as weak demand and we still have to see the benefit of that for consumers and corporate earnings. Low interest rates will stimulate corporate activity such as the interest from Swiss insurer ZFS in the UK group RSA. Lower valuations will support this trend.

The need for reform of the financial system and political structures has not gone away. The financial system is making progress with capital strength and clarity of reporting – capital ratios for banks and solvency 11 for insurance. Despite Greece calling an election and being pushed from the headlines politics and debt remain constraints for Europe. We have various elections this year, for instance in Spain. European political structures for decision taking and unified action are not strong enough and steps to strengthen them remain painfully slow.

Uncover investment potential via unconstrained strategy European reform is happening. Economic recovery is picking up in Europe and should be supported by a lower oil price. The biggest corrections have been seen in stocks associated with China - autos, luxury goods and miners. This has accelerated what was already happening after the clamp down on more conspicuous consumption. Newer market participants - flash trading, ETF and algorithmic trading have accentuated volatility. Volatility is not all bad and if patient creates opportunities. Many European companies have plenty of experience of operating with weak economic growth, uncertainty and volatile environments. There are many companies with strong balance sheets. Weaker players who have under invested and lack a clear strategy or good execution will be squeezed. Investors need to be selective as uncertainty and volatility will continue to be a feature as markets adjust..

Unconstrained investing strategy, which means building a portfolio without reference to the benchmark, means many areas of the market that are less attractive and where the risk return profile is poor are likely to be avoided: oil, mining, utilities. Instead a fairly concentrated group of stocks can be owned each in material size and still offer a diversified portfolio. With a time horizon beyond a few weeks selective positions can be added to in current volatility.

Eyes on opportunities arise from structural change

A few examples illustrate the opportunities where structural change is happening and should continue almost regardless of the pace of Chinese and world growth. The telecom sector is recovering from many years of aggressive regulation championing the consumer to a framework rewarding investment. Many of these telecom companies offer attractive yields and have predominant exposure to domestic European markets. Revenues can stabilise and after a long period of decline profits can grow.

Looking at other sectors in Europe, Ryanair the budget airline group is expected to benefit both directly and indirectly from lower oil prices. Their cost advantage over competitors should allow them to take share. Orpea the nursing home provider will continue their expansion plans to support the ageing demographics in Europe. There are many more examples in Europe across a range of sectors and countries where current volatility creates selective opportunities for investors, which could be captured through an unconstrained investing strategy.

Stan Pearson, Head of European Equities, Standard Life Investments

First published in the Hong Kong Economic Journal in September 2015