Proceeding with caution in Europe

Sam Morse, Portfolio Manager, Fidelity European Values PLC
August 2018

Investors in continental European markets appear increasingly cautious of late. This is not surprising given that we are, most likely, in the later stages of the economic and stock-market cycles. There is also uncertainty about the outlook in many directions: political and economic. In particular, there is a growing concern that protectionism will slow the pace of global economic growth.

Against this backdrop, it is somewhat unsurprising that equities have experienced heightened volatility over recent months. The Trust’s focus on investing in reliable dividend growers often tends to fare well in times of risk aversion.

At a sector level, technology has performed strongly - led by the strength of the sector in the US which has made European peers seem relatively inexpensive. This has benefited a number of our holdings such as Dassault Systemes, ASML, Amadeus IT Group and SAP.

A note should also be made on energy, where a strong oil price has helped major integrated companies such as Royal Dutch Shell and Total deliver on plans to improve operating and capital efficiency, enabling them to generate more cash and sustain attractive levels of dividends.

Although a high oil price is good news for these stocks, the fact that it is a key input cost for many European companies means that - with wages also rising - we may see margins come under further pressure from here.

In terms of the prospects for the broader market, an important factor to monitor will be whether the profit cycle has peaked, particularly as there is little valuation support and we are also at a time where financial conditions are tightening and the liquidity that has supported global equity markets since the crisis is being drained away.

Dispersion in valuations has grown with less favoured parts of the market such as the automobile and financial sectors appearing now to be very “cheap” if earnings hold up. So if sentiment swings again, markets could snap back with a sharp “value-led” rally.

Whatever happens in the short-term, we remain focused on attractively-valued cash-generative companies, with strong balance sheets, which have the potential to grow their dividends consistently over a three to five-year period. History shows that these types of companies tend to perform strongly over the cycle and we expect this to continue going forward.


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