WHAT a difference a year makes. Twelve months ago the European equity market was trying to work out what the implications would be for the European project given the result of the EU referendum.
The conclusions were broadly negative, whether perceived or otherwise. Europe was in the midst of another mini-banking crisis in Italy that turned into a maxi-crisis and politics were dominating the headlines.
What markets appeared to miss at the time was that growth at the margin was getting better. Twelve months on, growth has continued to get better and political risk has subsided post the Dutch and French elections although it has increased here in the UK.
The travails within British politics do seem to have given Europe more reason to present a united front and as a result this has clearly increased investor’s confidence in Europe - and in the euro for that matter
So, what does that mean for Continental European markets? Well, they have gone up and while valuations still look reasonable in the context of history, they are not screamingly cheap. Therefore it is crucial to analyse properly and understand fully the sectors and companies within one’s investable universe.
As markets have gone up on the prospect of better growth, there has been a debate about the valuation of sectors that did well in what had been deemed to be a low rate, low return, low inflation environment. Interest rates have not yet risen substantially but sectors that benefited from German bond yields being at historic lows were, and in some respects remain, relatively expensive.
One such sector is real estate, which remains driven by expectations around interest rates. This situation will probably persist until it is clear what the European Central Bank (ECB) intends.
However, one sector whose underlying fundamentals have been improving progressively over the last couple of years is the banking sector. Post a multi-year period of restructuring, capital raising, management change, and regulatory headwinds there are signs that things are getting better. Yes, the sector still suffers from over capacity and perceptions that Europe is ‘over-banked’ but now under the supervision of the ECB we are starting to see reason for more optimism.
One should not underestimate the significance of the moves in both Spain and Italy during June to take measures to help solve or at least reduce some of the potential tail risks. A year ago, it would have been impossible to deal with Banco Popular in Spain without sending tremors through the rest of Europe.
However, with a resolution mechanism in place and Spanish GDP growing nicely, Santander was able to buy Banco Popular for one euro. With demand picking up and lending moving in the right direction, the conditions are becoming ever-more supportive for banking franchises with robust balance sheets that are able to grow, take market share and pay high and attractive cash dividends.
Europe is also home to some of the leading companies that are beneficiaries of the move towards renewable energy and increasing scrutiny over emissions. Recent news around ‘cheat devices’ in German auto manufacturers and the phasing out of diesel and petrol cars in the UK continue to support that view.
Umicore, the Belgian speciality chemicals company, is very well positioned to benefit from the move towards hybrid and electric vehicles. It is a leader in cathode materials - the ‘stuff’ that makes the battery work - and has announced a six-fold increase in capacity to satisfy the accelerating demand.
In the same vein, Vestas, the Danish wind-turbine manufacturer, is continuing to grow its business through increasing demand across the globe for alternative sources of energy. This allowed it to deliver very strong growth in revenues and profits this year in addition to growing its dividend by 40 per cent.
So, for once, and probably for the first time since early 2011, Europe is in the spotlight for good reasons rather than bad. Confidence is slowly returning along with growth and politics have taken a back seat for the moment. In addition, European companies have addressed their cost bases and are demonstrating operating leverage, all of which presents a supportive backdrop for the trajectory of revenues, cashflows and dividends.
Will James is investment director, European equities at Standard Life Investments.
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