By Darius McDermott, managing director, FundCalibre
Europe is 7000 km (or 4349 miles in old money) away from China, but the Asian giant’s economic impact on the Continent, for good or ill, is significant. China’s ‘great reopening’ at the end of last year, and the start of 2023, was anticipated in Europe as a much-needed spark for demand for its goods and services.
Unfortunately, that spark hasn’t yet burst into flames the way it had been expected.
“China’s reopening and sharp relaxation of their strict Covid lockdown policy has provided less of a boost to both domestic Chinese economic activity and global trade than had been hoped,” admits Nicholas Williams, manager of the Baring Europe Select fund.
A spike in Covid cases, drags on Chinese business and consumer confidence from domestic policy uncertainty, and geopolitical issues that threaten further tariff rises and cross border trade issues, have not helped.
But it is not all doom and gloom.
The reopening coincided with a normalisation in logistics costs; air and sea freight rates have fallen back sharply from 2022 peaks. European companies, across a wide range of industries, are also welcoming the reopening-inspired improvement in component availability, as the supply chain issues created by the strict Covid lockdowns ease.
The Barings fund manager expects ongoing improvements. Both directly, with European apparel, sporting goods and luxury goods companies “hoping for more vibrant Chinese retail demand”, and indirectly, “in areas like medical technology and devices, where European companies anticipate Chinese hospitals broadening their investments away from short-term covid-related spending”.
Further out, China’s spending on their buoyant electric vehicle industry will provide more opportunities for European auto component and technology providers.
However, burned by its sputtering restart, some Europe-focused fund managers are tilting away from a reliance on the Asian superpower and looking closer to home for more reliable returns.
As air traffic between Europe and China is resuming from virtually nothing to an important part of long-haul journeys, the Waverton European Capital Growth fund, which owns a China-related play in German airport operator Fraport, will likely benefit. However, increasingly the fund is positioning to take advantage of a bigger theme dominating the investment landscape: disengagement from China.
Manager Christopher Garsten explains: “Just as China is trying to reduce its dependence on Western imports, especially technology, the West is trying to reduce its dependence on China. This has been given some urgency after the Ukraine invasion and ongoing Taiwan tensions,” he says. Waverton is poised to take advantage of this trend. Localisation or nearshoring is a theme in the portfolio, as is energy efficiency, digitisation and connectivity.
In a similar vein, David Walton, lead manager of the IFSL Marlborough European Special Situations fund, says he sees the best opportunities not in the China-focused European large caps like LVMH, but among smaller and more cyclical companies, which are currently out of favour with investors.
“These companies have underperformed the market but that could reverse as some of the negative factors that have weighed on growth lighten,” he said, pointing out, as an example of a disappearing headwind, the European spot price for gas is now below what it was just before the war started in Ukraine, and electricity prices have also fallen.
Walton is also hopeful European inflation may moderate in 2024. “Calling the top of inflation and interest rates is difficult, but there are signs from recent wage settlements, such as the agreement signed by the German trade union Ver.di,” he says.
The eurozone’s annual headline inflation rate fell to 6.1% in May from 7% in April, below the 6.3% predicted in a Reuters poll of economists. And this isn’t just an energy disinflation story. From non-energy industrial goods to services and even food, European consumer prices are now rising somewhat more moderately.
However at just above 6%, inflation is at a level that’s likely to continue to make the European Central Bank uncomfortable. Core inflation, which strips out volatile components such as energy and food, remains high as well, having printed 5.3%.
Nevertheless, Giles Rothbarth, portfolio manager of the BlackRock European Dynamic fund, says “it’s an exciting time to be investing in European equities given the breadth of opportunities available”. Giles likes, in particular, banks, semiconductors, and ‘green capex’, and it is worth looking at these a bit closer.
Banks, because 15 years of stringent regulation and capital base expansion, coupled with current interest rates, “means the European banking sector is more stable and more profitable than it has been in a very long time”, he says. At current prices many of these companies now offer 15% dividend and buyback yields, he points out.
Semiconductors he likes because Europe’s wafer fabrication equipment manufacturers have extremely dominant market positions, high and improving margins, and technological expertise that is almost impossible to replicate. “This in an industry that is expected to double in size over the next decade, with AI a new major tailwind,” he says.
Finally green capex. Europe is home to many of the world’s leading companies whose products and services are critical in areas such as electrification and decarbonisation.
Giles says: “These companies range from those at the forefront of innovation in green hydrogen, to industrial automation, to construction materials, to electric vehicle infrastructure. With trillions of dollars being spent in these areas, we believe these companies are extremely well positioned.”
Europe is a long and winding tale with its fair share of pitfalls, and of course the evil ongoing war. But China is far from its only saviour and, with so many homegrown opportunities, it shouldn’t be seen as such. European equities offer far more than just a China play.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
