Covid-19 and European equities: a Q&A with our fund managers
Covid-19 and European equities: a Q&A with our fund managers
In common with equity markets around the world, European shares experienced a sharp plunge in March as the coronavirus outbreak intensified across Europe. Stock markets have since recovered slightly from their mid-March lows but the outlook remains uncertain with economies still in lockdown.
We spoke to three European Equities fund managers about how they view the current situation and what the future may hold.
How have European equities performed during the coronavirus crisis so far?
Martin Skanberg: “It has been an extremely volatile few months. After gains of 26% for the MSCI Europe index in 2019 it is now down 19.0% year-to-date (as at 27 April).
“Looking within the market, there have been significant differences in sector performance. Sectors typically perceived to offer higher growth and/or be more defensive – like technology, healthcare and consumer staples – have proved relatively resilient. Unsurprisingly, sectors that are most sensitive to the economic environment – like financials, energy and industrials – have lagged.”
Past performance is not a guide to future performance and may not be repeated.
Leon Howard-Spink: “The healthcare sector in general has proved resilient. Within the sector there are companies operating in very specific niches that are outperforming. For example, Europe is home to companies that are market leaders in ICU equipment, including ventilators, as well as testing and vaccines specialists. Such companies are understandably seeing outsized demand.
“Other resilient niches include food production and semiconductors. These are also critical industries that are allowed to remain open and are experiencing strong demand.”
How will company profits be affected?
Martin: “Understanding the pace of corporate earnings downgrades is the market’s main focus in the near term. Clearly some sectors are more challenged than others here. Energy companies, for example, must contend with a collapse in the oil price as a result of oversupply and problems with storage capacity, as well as the sharp drop in demand due to the Covid-19 lockdowns.
“On average, earnings downgrades so far are in the region of 14%, much less than the downgrades witnessed during the 2008-09 Global Financial Crisis. However, that is unlikely to be the whole story as this crisis is still unfolding and it’s still unclear when businesses will be able to resume normal operations.”
What is the impact on dividends and companies’ financial strength?
Martin: “Many companies have already delayed or cut dividend payments and there will be more cuts to come. Again, the energy sector is likely to be one of the most affected, along with financials and industrials.”
Leon: “There are many specific industries that have been directly affected by the crisis, such as travel & leisure, clothing, retail and distribution firms. Some companies in these areas have seen their revenues dry up entirely. The question for us is to understand how long these companies can survive and any risks around breaching debt covenants (i.e. rules set by lenders). Many such companies could stand to benefit from pent-up demand when economies re-open.”
Paul Griffin: “As well as postponing or cutting dividends, some companies will need to refinance or raise new capital. Businesses that had rock solid balance sheets as recently as January are now having to cancel dividends and share buybacks and raise new capital instead. That’s a very sharp reversal of fortune. Clearly, cyclical businesses that were already more leveraged (indebted) will find this more challenging.”
How have measures announced by governments and central banks affected shares?
Leon: “The authorities have moved very quickly to announce support measures both for companies and for households. This is in contrast to the 2008-09 Global Financial Crisis and has helped to reduce volatility in the market from the extreme levels seen last month.”
Martin: “The monetary policy response has largely been about keeping credit lines open, which is critical for companies. In terms of the fiscal response, governments across Europe have come up with different measures ranging from wage support to rental payments. But it’s important to realise that these measures are designed to cover lost income rather than to boost growth.”
How have growth and value stocks performed during the crisis?
- Growth stocks have revenues and earnings that are expected to increase at a faster rate than the average company. Value stocks tend to trade at a lower price relative to their fundamentals, such as dividends, earnings and sales
Martin: “Growth has outperformed value for a substantial length of time now and that continued during the recent market turmoil. This is leading to high premiums for growth and quality companies. Does this mean there is an opportunity in value stocks? If the economy were to experience a rebound, as lockdowns are lifted and activity resumes, then economically-sensitive stocks could start to perform better. This raises the question of whether there is an opportunity in some of the better quality cyclical stocks.”
Leon: “I’d argue that the question of growth and value is often misunderstood. Look at the US for example, where a handful of growth stocks – the FAANGs (Facebook, Apple, Amazon, Netflix and Google) – have performed very well in recent years to the extent that they now represent a very significant part of the S&P 500. But the FAANGs aren’t the only source of growth in the world.
“And, likewise, ‘value’ doesn’t just mean challenged sectors such as oil, autos or banks. The key is to look at individual stocks and assess their growth prospects, and whether the share price represents value on that basis. We’re looking for companies that can achieve consistently high returns on invested capital, or that have the scope to improve those returns.”
Past performance is not a guide to future performance and may not be repeated. Chart shows relative price-to-earnings ratio for next 12 months. The forward P/E ratio divides a stock market’s value or price by the earnings per share of all the companies over the next 12 months. A lower number potentially represnts better value.
Where do you see opportunities currently?
Leon: “While some healthcare businesses are seeing elevated demand at present, I think that will continue beyond the current crisis. This situation has shone a spotlight on which countries’ healthcare systems were prepared for a pandemic and which were not. I would expect to see sustained higher levels of healthcare spending as governments ensure health services are better equipped in future.”
Martin: “It’s also the case that we were already in the midst of a period of healthcare innovation that is bringing exciting investment opportunities. In many cases, the market valuations of such companies do not adequately reflect their future growth potential, in my view.
“The technology sector is another area, on the software side, but also in terms of demand for semiconductors. The move towards the electrification of cars will see increased demand for power chips, for example.
“Restructuring stories, where companies are transforming themselves to meet new challenges, will also continue to be a rich area of investment opportunities.”
Leon: “The crucial thing is that the opportunities will be found at a stock-specific level. Companies with the greatest potential for sustainable growth are those exposed to trends that are independent, in many ways, from the overall level of economic growth. Changes in consumer behaviour; higher demand for testing and safety assurances; the shift towards green energy. These are examples of trends that could offer higher growth.”
How do you see the outlook for sustainable investing?
Leon: “The current crisis could be a catalyst to accelerate trends that were already in place. A greater focus on ESG (environmental, social, governance) issues may well prove part of this. There could be scope for greater investment in greener transport, such as electric cars and high speed rail. The switch towards renewable energy and energy efficient, longer-lasting buildings could also pick up speed. The current crisis offers capitalism the opportunity to prove its worth, by ensuring investment for the future is made in the right areas.
Martin: “Carbon awareness has been growing on a personal level but it’s an EU-wide issue now too. The European Commission has proposed its Green Deal and there are numerous companies that could benefit from this.”
Could the current crisis cause the breakdown of the eurozone?
Martin: “The crisis has brought a sudden stop to economic activity and that puts a huge strain on any society or institution. It’s also true that some countries in Europe, such as Italy and Spain, have suffered to a greater extent than others and so solidarity will be important. A breakdown is plausible, but we need to recognise that the European Central Bank is a very powerful entity and it has moved in with support.”
Paul: “It’s also the case that companies listed in Europe don’t only have clients and customers in Europe. Many are global firms operating in many different geographies and facing different challenges in each.”
Leon: “For as long as the eurozone has existed, investors have worried that it might break up. That often leads to companies listed in Europe being valued at a discount compared to their peers in other regions. But it’s not something that we focus on, or we’d risk missing out on the stock-specific opportunities available to us.”
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