European equities have trailed their global counterparts 30% since 2015 and closer to 65% since the trough of the financial crisis. Driving this has been a plethora of worries, as it wasn’t that long ago that we were questioning whether the EU could actually fall apart.
Fast-forward to today and European exposure may even seem alluring, with a combination of low prices, strong corporate earnings growth, and some of the best economic conditions in a decade. In fact, Europe ex-UK earnings growth was 18.7% over the 2017 calendar year, far greater than the 3.4% average annual decline in the decade prior. Even dividends increased at a stellar rate, with 2017 recording 3.9% average growth in per-share dividends.
So, the fundamental landscape has seemingly changed. Yet, not all sectors and countries are benefitting, which is where it becomes interesting. Despite being a developed market with strong coverage, arguably making it more efficiently priced,, the continent is still extremely fragmented.
For instance, European telecommunication companies are down 11.7% over the past three years to the end of March 2018, whilst French equities have increased by 22.1%. Hence, sector and country dispersion are important levers to pull in their ambition to maximising returns and/or minimising risk. The same goes for size, where small caps have significantly outperformed their large equivalents.
Finding Unloved Sectors
Bringing this together, the market reality is still incredibly complex. In the long-term – the period most investors should care about – investors need to determine whether they want a broad market-cap weighted exposure, or to select individual opportunities within the European landscape.
Based on the most recent analysis, the biggest opportunities reside within unloved areas such as European telecommunications, eclipsing the more popular areas such as US energy or US financials.
Within Europe, the return expectation is closer to 5.6% a year for European telecommunications versus just 3.0% for European equities in aggregate - in real local currency terms. These are far in excess of the US equivalents, although US healthcare looks reasonably attractive to us with an expected return of 3.0% and offers an alternative performance driver.
By extension, emerging Europe may also have distinct appeal as it is expected to deliver 4.5% a year and is often disregarded by investors. Part of the reason is that gaining exposure can prove problematic for end-investors, as it is not typically covered in the broad market and makes up less than 15% of emerging markets. The key is not to be afraid to allocate a dedicated position to a country or regional fund, especially when disparity in valuations is apparent.
