We talk to fund managers about the prospects for the single currency and Eurozone shares
Thursday 10 Jan 2019 Author: Holly Black

This month marks two decades since the introduction of the euro, when 12 European nations cast aside their own currencies to unite under a single coin.

As the euro launched in 1999, investors saw spreads between core nations such as Germany and France tighten with those of peripheral members such as Greece and Portugal.

Ian Ormiston, manager of the Merian Europe ex UK Smaller Companies (BRTNQ88) fund, explains: ‘The cost of capital tumbled for peripheral equity markets and their perceived risk premium collapsed.’

SPREADS HAVE WIDENED AGAIN

Today, however, Italian government bonds are trading around their widest spread in five years compared to German bunds. At the start of 2019, Italy’s budget is one of the key issues facing the eurozone. It’s just one of many clouds over the investment outlook for the region.

The value of the euro is holding steady against other major currencies, but its future remains in doubt. The UK’s decision to leave the European Union along with the rise of populist political parties has sparked concerns that more countries could try to leave the union or its currency.

Thomas Brown, co-manager of Miton European Opportunities (BZ2K2M8), says: ‘The euro, like Facebook, was supposed to bring us all together. But it has had the opposite effect; driving substantial divergences in Eurozone economies, which currently appear insoluble. Currency union without federal union looks doomed to fail.’

Indeed, the union has faced a number of unprecedented issues over the past decade, as the European Central Bank has tried to manage its way out of a global financial crisis with member states at varying states of boom and bust.

REGION FACING SEVERAL HEADWINDS

In 2018, Europe had to cope with myriad headwinds, including trade war concerns, political uncertainty in Italy and the UK, and monetary tightening in the US. Growth in Europe was just 0.2% in the three months to November – its lowest level in more than four years – and ECB President Mario Draghi has said the base rate is unlikely to rise before the summer.

Despite that, many fund managers remain optimistic about the year ahead. A recent rout has seen company valuations fall, but Edward Greaves, co-manager of the JPM European Smaller Companies (JESC) trust, points out that earnings growth for many smaller firms on the continent is forecast to be close to 10% this year.

He is particularly upbeat about the outlook for businesses in the healthcare and technology sectors. He has investments in Swiss firm Vifor Pharma and French consultancy company Altran Technologies. The trust has returned 17.3% over three years.

Chris Hiorns, manager of EdenTree Amity European (0844833), thinks the European economy as a whole looks to be in much better shape than it has been for the past decade. The introduction of new emissions controls has hurt the automotive sector, but he thinks it’s a temporary issue, which could provide an investment opportunity.

FOCUS ON LOWLY VALUED CYCLICAL STOCKS

Hiorns is focusing on cyclical stocks trading on low valuations, yielding 4% or more. Among the constituents of the portfolio are tyre manufacturer Michelin, recruitment firm Randstad, and building materials company St Gobain. The fund has returned 25% over three years.

Merian manager Orimston says: ‘As a stock picker, it has been possible to find companies unaffected by their local bond market woes. Germany’s domestic market has never been so strong, as its export sector has been hampered by the relentless rise of the Deutsche Mark. Even in Italy, we are able to find manufacturers that have benefitted from the crushing of domestic inflation.’

Some 7.2% of his fund’s assets are in Italian equities with other investments in German, French and Dutch stocks. Top holdings include Belgian manufacturer Ontex Group and Norwegian retailer Europris. The fund has returned 16% over three years.

James Sym, manager of Schroder European Alpha (B6S00Y7), is looking for companies that are likely to benefit if inflation picks up. This includes sectors such as telecoms, where the infrastructure needed to supply services already exists so capital expenditure isn’t too high, and rising wages mean customers can bear price rises. 

He also likes financial firms, which are able to increase their rates on loans and other products as inflation creeps up, helping to boost revenue. The fund has returned 20.8% over three years.

VOLATILITY SET TO PICK UP

Two decades on from the launch of the euro, the outlook for the region is by no means a simple one to navigate. Brown thinks growth - both economic and earnings - will be lower this year, while volatility is likely to pick up. His fund, which has returned 50.3% over three years, invests in names including Ferrari, Finecobank and Netherlands eyecare retailer GrandVision.

While fears abound about potential recession, trade wars, rising rates and political crises, it is important to remember that a country’s stock market often has little to do with its political or economic environment. So much uncertainty often creates opportunities for stock pickers who can cut through the noise.

Miton man Brown adds: ‘Our approach is not to spend time second-guessing the macro-economic environment, but to focus on owning the few great world leading-companies in Europe that we think will continue to perform well whatever the economic weather.’

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