Fidelity European Trust PLC portfolio manager Sam Morse provides his unique insights on why there are reasons to be both cautious and optimistic for European equities over the coming year. With markets so finely balanced, his focus as ever remains on finding attractively valued companies with good prospects for cash generation and dividend growth over the longer-term.
Investors are widely expecting 2021 to be a year of recovery, with earnings and dividends bouncing back from the weakness in 2020. However, recent strength in markets suggests much of this recovery may already be reflected in share prices, while any problems in the distribution or efficacy of vaccines could spark further volatility. Against this backdrop, our mood is one of cautious optimism.
Markets are finely balanced: the most likely ‘surprise’ is that company earnings don’t recover to the extent that analysts are predicting, leading to disappointing stock performance. We are also keeping an eye on the US, where we are wary of slowing growth. However, Democrat control of the senate means President Biden now has a slim majority with which to pass his stimulus package - a more encouraging sign.
Europe has its risks: government debt levels across the region are high, particularly in Southern Europe, and it remains to be seen how much this government largesse has delayed rather than averted future pain for the economy. However, companies in Europe draw their income from across the globe. This means we have a good choice of attractively valued companies that should sustain consistent growth even if the outlook for the region is uncertain.
The Covid legacy
At a sector level, it remains to be seen how much of the change brought about by Covid-19 is here to stay. Certainly, the pandemic has accelerated key structural trends. The obvious example is technology, where the pandemic has brought forward demand from consumers and businesses. We don’t see this reversing. At the same time, while we should expect to see some recovery in the sectors hit hardest by the virus, many may not recover to previous highs. For air travel, for example, even a full reopening of the global economy seems unlikely to generate pre-Covid passenger volumes.
Covid-19 has generated an increasing focus on sustainability, which looks set to play an important role in asset flows and share price returns. Europe as a region typically has high standards of governance when compared to other markets. Our focus on sustainability of dividends typically leads us to favour the types of companies that are highly rated on ESG (environmental, social, governance) and sustainability grounds.
Positioning for a new era
Within the portfolio we are striving to keep a balance of sectors and our focus is on finding attractively valued companies with good prospects for cash generation and dividend growth over the longer-term. We see clear opportunities in technology. Microsoft’s CEO Satya Nadella spoke in April 2020 saying “we have seen two years’ worth of digitalisation in two months” and we continue to chart a similar pattern in many of our holdings. We are confident that this area of the market continues to offer good growth over the long term; SAP, Dassault Systemes and Prosus are all important holdings in the portfolio.
In terms of areas we are avoiding, we are careful on valuation. We are particularly wary of those sectors where the market is beginning to price in a greater near-term recovery than we think likely, business travel and hospitality, for example. We are also cautious about more fashionable parts of the market where some popular companies enjoy valuations that are not justified by the prospects.
This is an important inflection point in markets and while we recognise that there are reasons to be optimistic, we see reasons for caution as well. Our portfolio reflects this balance, focusing on the sustainable growth stories of tomorrow, while keeping a watchful eye on valuations.
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