European Fundamentals Remain Fairly Steady, But Political And Economic Issues Warrant Caution
By Richard Nield, Senior Portfolio Manager posted on Expert Investment View: Invesco US Blog
The end of 2015 didn't bring any dramatic changes to European fundamentals. However, there have been some subtle shifts that the Invesco International and Global Growth team is keeping an eye on in 2016. While our strategy did not initiate any new positions in Europe during the fourth quarter, recent volatility has brought some of our "watch list" names closer to the point where we would add them to the portfolio.
The long-term economic impact of Germany's migrants remains unclear
There is some uncertainty as to how the influx of 1 million migrants will affect Germany, both politically and economically. Politically Chancellor Angela Merkel's popularity, which had been stable for years at 70%, has fallen to around 50%1 as there are fears the migration crisis and terrorist threat are tied together. The market will be concerned if there is any indication she might not win another term. She has a year and a half to fix the problem before the next national elections.
Economically, the influx of migrants should act as a short-term tailwind to gross domestic product (GDP), potentially to the tune of a 0.5% increase. However, the medium- and long-term effects are less clear and will depend on how quickly they can be integrated into German society. Elsewhere on the economic front, we have seen sectors such as autos and engineering companies tumble on export concerns, as Germany has the highest exposure to China among European countries.
Fears of a 'Brexit' continue in the United Kingdom
Fears of a "Brexit" (a British exit from the European Union) remain a concern in 2016 as it could cause more splintering in the region. Also, the pound sterling has depreciated to 2009 lows as the Bank of England reversed its tone and pushed out any thoughts of an interest rate hike, unlike the US Federal Reserve.
UK economic indicators are slowing. Fortunately our UK exposure within the Invesco International Growth strategy has been relatively defensive. We continue to overweight the UK versus our benchmark because of the strong defensive growth characteristics of our holdings there. On the other hand, in Continental Europe it has been more difficult to find new companies that have attractive enough valuations for our strategy.
Volatility has made certain names more attractive
When we examine how our European positions look under our EQV (Earnings, Quality and Valuation) criteria, it is clear that earning fundamentals have regressed in the last three to six months. We are seeing consistent earnings downgrades based on slowing global growth. In our view, two traits that help our strategy in times like these are:
- Our aversion to companies with high debt loads.
- Our focus on high-quality, cash-generative business models.
We continually keep an updated watch list of intriguing names, and during times of market stress we look to add new high-quality growth companies to the portfolio. The good news is that the market correction in early 2016 has brought some of our watch list names closer to the point where we would add them to the portfolio; these include high-quality cyclical stocks in the spirits, financials and capital goods sectors. Conversely, most low-quality cyclicals and defensive sectors such as consumer staples and health care look rich. Our strategy did not invest in any new companies in the fourth quarter as we remain disciplined with our entry points.
Overall, it is fair to say that the European region has seen a slight slowing of growth sequentially, but not enough to change our current view and positioning. We still see better fundamentals in companies that depend on international markets to balance out growth opportunities.
- One example is Unilever (NYSE:UL) (1.25% of the Invesco International Growth Fund (MUTF:AIIEX) and 1.15% of the Invesco European Growth Fund (MUTF:AEDAX) as of Dec. 31, 2015), a multinational consumer goods company that reported strong fourth-quarter results. The company, co-headquartered in the Netherlands and the UK, is gaining share in Europe - but the Americas and Asia Pacific are where it continues to see the best growth, helped by its innovation program and strong distribution platform.
- Another example is German software giant SAP (NYSE:SAP) (1.90% of Invesco International Growth Fund and 1.67% of Invesco European Growth Fund as of Dec. 31, 2015), which delivered another strong quarter led by its Cloud software business that is enabling them to take share from the competition. SAP is seeing solid growth in most markets because of its competitive positioning.
Learn more about the Invesco International Growth Fund and the Invesco European Growth Fund.
- Associated Press, Nov. 13, 2015
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.
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Volatility in Europe may reveal new investment opportunities in 2016 by Invesco US Blog