Sam Morse, portfolio manager of Fidelity European Values PLC and the Fidelity European Fund, gives his outlook for the region in 2020. Given the uncertain outlook for Europe, he discusses why a cautious approach - focused on attractively-valued and robust dividend-payers - is well placed to reward investors over the long-term.
- European markets had a good run over 2019, despite continued worries around US-China trade tensions, a slowing global economy and Brexit.
- A focus on companies with strong balance sheets, disciplined use of capital and proven business models will be key to navigating what remains an uncertain macro environment in Europe.
- This leads us to gravitate towards sectors such as health care, consumer staples and technology, which exhibit steady growth.
There appears to be growing evidence that the triple threat of US-China trade tensions, a slowing global economy and Brexit have negatively impacted economic growth, with trade-related sectors hit particularly hard. Central banks, however, have come to the rescue. The extra liquidity should help to support European stocks in the short-term, even if fundamentals don’t improve markedly.
There has also been more noise about fiscal easing, although European governments finances will be a constraint. With all these factors still in play, the outlook for next year remains uncertain. Against this backdrop, my focus will remain on companies with strong balance sheets which are able to grow their dividends consistently.
Is the tide turning?
The main risks for the near-term remain anchored around geopolitics and central bank activity. Trade tensions rumble on and Brexit remains a source of uncertainty. A key turning point for investors however has been the Fed “pivot” to ease monetary policy. The European Central Bank has followed suit as evidenced by the September meeting where they agreed lower deposit rates and the reintroduction of asset purchases which should be supportive of equities.
Many indicators seem to be suggesting, however, that the long economic and stock market upturns may be nearing their end. The conundrum is that the market already seems to be anticipating this given the growing dispersion in valuation between companies. Investors appear to be very sceptical of the sustainability of earnings in more cyclical sectors.
Exhibiting steady growth
I run a balanced portfolio in order to mitigate risk and overexposure or underexposure to certain sectors or macroeconomic factors. The highest weightings gravitate to sectors such as health care, consumer staples and technology, which exhibit steady growth.
I usually avoid holding companies which are overly sensitive to the economic environment such as automobiles. These cyclical companies can grow dividends in good times but can also underperform significantly when conditions are not favourable. Although it is perceived to be a defensive sector, I am also underweight insurance stocks as I believe there is more valuation upside in some of Europe’s stronger banks.
Stocks over sectors for 2020
The portfolio aims to stay fully invested and will continue to maintain a bottom-up stock selection approach with a focus on attractively valued companies with the ability to grow dividends sustainably over a three-to-five-year horizon. As a result, I aim to generate out-performance through company selection, rather than through aggressive sector or country bets. Alpha is delivered from across the market-cap spectrum, but the contribution of larger-cap stocks is significant.
As a result, the primary driver of portfolio returns will come from stock section rather than sector positioning. I believe companies where I have the highest conviction - the likes of Nestle, Deutsche Boerse, LVMH and Roche amongst others - will continue to be the source of outperformance over the long-term.
For example, a significant proportion of Nestle’s business is in categories with both strong growth and high emotional engagement with scope for premiumisation. Since the CEO change in 2017, this has become a ‘restructuring story’ - by further streamlining the portfolio and exiting lower value-added businesses they should continue to improve operational efficiency and organic growth. I expect organizational changes to drive faster and more relevant innovation.
Elsewhere, Deutsche Boerse will also likely remain a key holding as most of its revenue is derived from high-quality, high-margin, monopoly-like businesses (Eurex and Clearstream). Deutsche Boerse has a portfolio of interesting growth-assets (EEX, 360T) which can deliver high single-digit growth and help diversify the business.
Strong balance sheets, disciplined use of capital and proven business models are in my opinion key features to focus on in an uncertain European economic environment.
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