Equity investors, both in Europe and globally, have had plenty to deal with in 2018 – the first populist government in Italy, a political crisis in the UK, trade wars and generally weaker macroeconomic data. Consequently, European equities have been heavily sold off as investors reacted cautiously, ignoring by and large robust macroeconomic and earnings fundamentals.
Are things that bad?
There’s no getting away from how pessimistic investors have become. Tarnished by various crises in the last 10 years or so it’s easy to be gloomy. What matters to us as fundamental, valuation based investors is to assess if the outlook is as negative as what’s being priced in. Even if things are only ‘less bad’ there are opportunities to be had.
To us the outlook for domestic demand looks good as Europe recovers from the various crises of the last decade. Corporates are regaining their appetite to invest again whilst falling unemployment and rising wages are supporting consumption. So what about the macro weakness we’ve seen more recently? Q3 economic data has been distorted by the disruption caused in the auto sector from the introduction of new WLTP emissions regulations. This headwind should now fade if the more recent data is anything to go by. Can trade tensions overshadow domestic demand? If there was an escalation of trade wars, this would almost certainly impact growth but we cannot ignore the strength of domestic demand. This should at least provide some mitigation in a very negative scenario and leave the economy better placed to bounce back afterwards. All in all Europe is still on track to deliver steady if unspectacular growth.
Another encouraging sign of Europe gradually returning to normal after various crises is inflation. Core CPI, the more relevant gauge, has been steadily ticking up for some time now. Wage growth, a key driver of inflation, is firmly on an upward trajectory not just in Germany but in the periphery too. With employment set to rise in 2019 the omens look good. Overall this should provide a solid economic platform – a combination of robust demand and improving pricing trends - for European corporates.
It’s hard to ignore – despite the various political headwinds – how robust earnings are. Most indices – be they Pan European, Continental European or Eurozone – are on course to deliver mid to high single-digit EPS growth in 2018. It’s not all from Energy either. Banks and Insurers have played their part too.