Q What is your view on 2019 and how does that influence your outlook for 2020?
2019 has so far been a good year for European equities, but this was largely driven by price-to-earnings (P/E) multiple expansion rather than improved company earnings growth.
At the time of writing, companies had only managed to grow their earnings by 1% on average over 2019 – a much lower figure than the gains made by stock markets over the year. In light of current market valuations, we believe it will be hard for stock market returns to continue to rise over a sustained period in the absence of stronger earnings growth. That means we expect European stock market performance to look more balanced in 2020.
That said, we expect diverse drivers to influence performance at the individual sector level and lead to an array of investment outcomes. This should create ample opportunity for active investors and underscores the importance of a robust and selective approach.
Q How has the backdrop changed?
We expect the economic impact of Brexit and US-China trade to be resolved, or at least clearer, in 2020. This clarity creates room for any positive signs around company earnings to lift equity market returns.
We see particular potential for this to play out in cyclical sectors. Relative to the US and China, exports play a greater role in European economies – making cyclical companies in Europe particularly sensitive to trade-related uncertainty. Valuations of these companies are currently discounted to reflect the current trade tensions. Should improving trade dynamics feed through to higher earnings expectations, we see significant potential for stock price rises.
Even if stronger earnings growth does not materialise in 2020, recent economic data releases lead us to believe that a weaker outlook for the economy is already being anticipated in market valuations. The Purchasing Managers' Index (PMI) indicators, for example, are generally at the low end of their historical band, which often coincides with a bottoming out of expectations. This can be compared to early 2018, when PMIs were at peak just before economic expectations weakened for two years.
We therefore believe any potential recession should be mild. Moreover, we would expect that if growth surprises on the downside, this will encourage companies to take the opportunity to rebalance their costs, which can be a positive for sustainable earnings growth.
Q Where are the potential opportunities and how are you positioning the portfolio?
New opportunities should arise as certain stocks and sectors have sold off unfairly for various reasons. We aim to capture such opportunities through our 4Factor investment process.
We believe some pent-up demand in economic activity will come through as geopolitical issues are resolved in Europe. Whilst we have reflected this in our current positioning, such as in financial and semiconductor stocks, we will continue to be on the lookout for new ones. Recently we have noted some potential in a few automotive and building material names.
We aim to maintain a balanced portfolio. Our analysis shows that valuations of quality stocks are at 20-year highs, leading us to ensure we continue to have clear valuation cases in stocks we purchase.
With this disciplined approach, we will continue to seek out evidence-based investment opportunities that we believe will deliver good returns to investors over the long term.
All investments carry the risk of capital loss.