Following the historic crash witnessed during the first quarter, European markets rebounded strongly over the second quarter with investors shrugging off the negative press and the macroeconomic indicators, and instead focusing on the positives. The gradual re-opening of economies together with the huge monetary and fiscal policy support also boosted equity market performance.
Against this more buoyant backdrop, the strategy behind the Fidelity European Fund and Fidelity European Values PLC has marginally outperformed the respective indices over the quarter, mainly due to strong stock selection. However, winners from Q1 became the laggards over Q2, with healthcare and telecommunications amongst the worst performing sectors outside of energy.
The strategy’s focus on strong and sustainable dividend-payers has been a major cushion during more challenging periods this year, while the relative marginal underperformance over June reflects the anticipated strategy behaviour given the market’s rotation.
Murky dividend outlook
Looking ahead, one of the greatest challenges today is how to assess dividend growth as a marker of company quality. The dividend guide may be a flickering candle now rather than a bright torch, but is still very useful in these dark and difficult times.
Overall, the dividend picture has become very confused, with many companies reducing, delaying or even omitting dividends under pressure from regulators, governments and, in some cases, even their own shareholders. Whilst the situation remains challenging, we are beginning to establish clearer expectations for companies for the year.
Our analysis is broadly encouraging with over 60% of holdings expected to grow their dividend payments this year and around 20% expected to cut by more than 25%.
Unlike previous downturns, it is probable that dividends will fall more than earnings, and we are already seeing evidence of the relationship between dividend yields and dividend per share growth breaking down.
Our strategy is to continue to treat each company held on a case-by-case basis (paying a lot of attention to valuation), while staying cautious of those companies that are reducing dividends whatever the public explanation.
There are three important questions for what comes next.
What will be the shape of the recovery: V, U, L, W?
While the market has seen something of a V-shaped recovery so far, our view is this will prove to be a more of a W for the European economy, as longer-term demand is expected to be subdued.
Indeed, many of the companies we speak to are telling us that they are still very uncertain about the outlook and are therefore cutting capital expenditure, investment and discretionary spending.
We expect that the inevitable recession will prove longer than is currently anticipated - underlying demand is weaker than is being priced-in as government and central bank policy defers, rather than removes the risks to the real economy.
Will this ultimately be inflationary or deflationary (lower for longer)?
In the short-term, central banks are buying bonds to keep rates down and governments are promising massive fiscal stimulus packages. We have seen evidence that fewer companies than might have been expected to collapse just a few months ago will do so.
European governments have proven more robust than expected in measures to keep firms afloat - airlines for example. If current policies continue, we can expect a lower for longer disinflationary environment.
Will this lead to a new eurozone crisis (is Italy too big to fail)?
To date policymakers have proven surprisingly amenable to cooperation, albeit intentions must translate to formal agreement. In reality, little progress has been made since the Eurozone crisis and government debt levels remain too high (particularly in Southern Europe) and the current high levels of fiscal spending will exacerbate the problem. This is a concern and it is something we expect investors to become increasingly nervous about.
While the outlook for Europe remains uncertain, we continue to find attractive stock picking opportunities. Continental European equity markets are a diverse hunting ground for investors with many best-in-class, global companies offering good growth and diverse revenue streams. These companies can find themselves marginalised due to near-term concerns associated with the region, which creates opportunity for the long-term investor.
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The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. The Fidelity European Fund and Fidelity European Values PLC can use financial derivative instruments for investment purposes, which may expose them to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Changes in currency exchange rates may affect the value of investments in overseas markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.