Fund managers are downbeat on the prospects for the European economy yet Blackrock and some fund buyers have moved overweight the region’s equities in recent months as a play on higher medium term inflation and Covid recovery.
According to the latest European Bank of America Merrill Lynch fund manager survey, only 44% of participants expect the European economy to improve over the next 12 months. This is the lowest proportion since June 2020 and a sharp decline from 80% last month and March’s peak of 94%.
But more than half the managers surveyed remain bullish on the continent’s equities, with 51% expecting the equity rally to continue until next year and fewer than 5% expecting downside for European equities by the end of the year.
Blackrock spies the ‘new nominal’
Indeed, Blackrock has shifted overweight European equities in response to what it terms the ‘new nominal’. In its latest mid-year outlook, the asset manager says for the rest of 2021 it expects higher medium-term inflation as a result of more muted monetary policy response to inflation than in the past.
It explains: “The new nominal is about government bond yields being less sensitive than in the past to higher inflation expectations and actual inflation, keeping nominal long-term yields low and real yields negative.”
The asset manager sees this scenario as constructive for equities, in particular cyclical shares in regions set to benefit from a broadening restart, most notably Europe.
“The powerful economic restart is broadening, with Europe and other major economies catching up with the US,” Blackrock says.
It adds: “We see a sizeable pickup in activity helped by accelerating vaccinations. Valuations remain attractive relative to history and investor inflows into the region are only just starting to pick up.”
In terms of cyclical sectors in Europe it pinpoints technology and financials have lagged US peers since last March but are due to make up lost ground.
“We believe these sectors could be well positioned to play catch up as the restart broadens beyond the US,” the outlook says.
End of 2020 was looking good for Europe
Whitechurch Securities investment manager Tim Jones (pictured) says the DFM increased exposure to European equities earlier this year due to the improving outlook for the region. He says thinking back to the end of last year, there were reasons to be excited about European equities.
“A deal of sorts had just been reached with the UK and after four years of deterioration of transatlantic relationships, Joe Biden’s presidential election victory offered much promise of parity on issues such as defence, technology and international trade,” he says. “The prospect of a lower carbon economy was also once again propelled into the spotlight – one which Europe is touted to benefit from.”
Fast-forward to today and Jones says economic data, both in the shape of services and manufacturing PMI, makes for encouraging reading and valuation multiples remain attractively below those in North America. Perhaps most relevant, however, has been the improving coronavirus vaccination take-up in Europe over the past six months, he notes.
“Although often talked about as a broad asset class, the complexity of the continent offers a degree of diversification not found across all other major developed regions,” he adds.
Europe dogged by value tilt and political backdrop
AJ Bell head of active portfolios Ryan Hughes says European equities have been out of favour with international investors for a long period, not least due to the market’s strong value tilt which has been unattractive until the past nine months. That is combined with a political backdrop that has always left question marks about how business friendly the bloc’s politicians were, he adds.
“In recent months, the vaccine boost has helped European equities perform well on hopes of a pick-up in economic activity but given the ECBs propensity to shoot itself in the foot, investors have been reticent to significantly increase allocations,” he says.
Hughes thinks it unlikely the ECB will raise rates anytime soon, particularly having seen with current market wobbles due to fears the Federal Reserve will have to raise sooner than expected. He notes the ECB’s stimulus programme is phased over a much longer time period and has therefore not given the economy an immediate boost, while high unemployment means the bank will likely be more cautious than the Fed – both of which could view as providing a useful backstop to the market.
However, AJ Bell has just a 3% exposure to European equities in its medium to higher risk portfolios on the basis of lower expected growth over the long term compared with other markets. It uses the Barings Europe Select fund in the actively managed portfolios which provides access to high quality small and medium-sized companies.
Hughes says: “We see these as better placed to capitalise on the long term opportunities than the larger cap end of the market which has the potential to be harder to transform given the political environment.”
