Janus Henderson: En Marche! for European equities

With Europe offering political uncertainty, muted economic growth and squabbles about Brexit, few would have guessed that the region would provide some of the best equity performances in the first part of 2017. European equity returns, are well ahead of the US (even with the help of the Trump trade) and well ahead of the other main equity markets, apart from Mexico, which has been boosted by a rally in the peso. What has been going on?

Part of the answer has come with the election of Emmanuel Macron as French president in early May, just a year after founding his centrist political party En Marche! (On the Move). Voters rejected Marine Le Pen, who wanted to take France out of the euro, a move that would have weakened the EU, perhaps fatally. Even though a third of French voters opted for a candidate from the far right, the majority backed a pro-EU candidate who has talked about the need to reform the EU from within and to improve France’s economy. Bearing in mind that previous reformist French presidents have failed to implement meaningful changes, Macron has a huge challenge – but at least he has a mandate.

A reprieve from the forces of populism
Macron’s win came on the heels of a Dutch vote in which the far-right candidate Geert Wilders failed to make progress. So there is a growing sense that the march of populist nationalism has come to a halt, at least for now. Of course there are still risks ahead, with a German election and potentially an early Italian election later this year. But the French vote certainly gives some space to France and the EU (ie, Germany) to come up with an agenda to show voters that the EU can address the issues that have led to low growth in France and Italy and the protest/anti-globalisation votes that have followed.

Apart from reduced political risk, European equity performance also reflects slowly improving economic fundamentals. Gross Domestic Product (GDP) growth estimates have edged up in France and Spain; meanwhile Germany performs better than ever.  Construction activity is reviving in many countries after years of permafrost. Instead of deflation, discussion now focuses on when the European Central Bank will wind down its bond-buying programme.

Is Europe closing the valuation gap?
Another element to equity performance has been corporate results. As in the US, many European companies have produced resilient quarterly earnings; even European banks – which can normally be relied on to spoil a party – have mostly been well-behaved. Another factor fuelling performance has been valuation. European companies have been catching up with higher valuations in the US and corporate investors have been also trying to exploit the valuation anomaly. Just one example is US coatings group PPG, which has tried to acquire Dutch rival Akzo Nobel, eventually tabling a bid for $29 billion – more than a 50% premium over Akzo’s prevailing share price. Another obvious example was the attempt by 3G to buy Unilever and thereby improve its performance. Even outside bid territory, some of the companies I have reviewed recently have shown particular strength:

• France-based service group Spie saw its shares rise by almost 50% over the six months to the end of April 2017, based on a well-priced acquisition and greater optimism about its activities in France.

• French flooring group Tarkett has also risen by over a third over the same time period on strong results and optimism that its performance in Russia will improve.

Elsewhere there has been strong performance from some specialist industrial groups. These niche players are a European strength and range from makers of specialist equipment for mining (in revival after huge destocking), logistics equipment, such as fork-lift trucks, and tools for the semiconductor industry. These areas have performed much more strongly than the staples and defensives that have led the market since the financial crisis.

What now? 
With renewed confidence in the outlook for France, electronics retailer Fnac may be worth a look. Retailing is a notoriously difficult investment area, even harder now because of competition from the internet and groups like Amazon. But Fnac is interesting because it has recently merged with rival Darty and is now France’s largest electrical goods retailer. Price competition from supermarkets and online rivals is easing. And a talented management team that consists of significant shareholders has every incentive to harvest synergies and lift profitability towards that achieved by operators elsewhere. Longer term, Fnac is probably a consolidation target itself.  

This article represent the fund manager's views, taken in the context of his European growth-focused strategy. None of the content of this article should be considered investment advice.  Past performance is not a guide to future performance. Investment returns are not guaranteed and you may not get back the amount originally invested.