Where to find the bright spots in European equity markets

26th January 2016


Niall Gallagher, investment director at GAM, highlights opportunities in Spain, Ireland and sectors including consumer, healthcare and industrials…

Many of the macroeconomic imbalances that have put a strain on Europe over the last few years have finally been unwound. Deleveraging has permitted the emergence of a positive credit impulse which is driving a strong rebound in domestic demand in the peripheral economies. European equity markets, taken as a whole, are on the somewhat cheap side of fair value, but there are clear areas where investors can achieve desirable returns.

We are seeing the best investment opportunities in the two stars that burned so brightly in the 2000’s – Spain and Ireland – where the level of domestic demand has corrected to such a degree that we see a multi-year bounce in internal demand as inevitable. This trend, combined with the operational gearing consequences for companies that are ‘survivors’, has multiple years to run, in our view.

Although there are large sections of the market where we think return on equity won’t return to prior levels, there are significant areas across consumer and industrial sectors that will experience a strong earnings rebound. This is particularly true in peripheral economies, where rising consumer and industrial spending, falling unemployment and rising confidence should boost company profits.

There are also sectors where we are seeing signs of structural improvements to profitability, such astelecoms. Select telecom stocks are about to enter a virtuous cycle of rising revenues, falling costs and lower capital expenditure. This will drive a significant expansion in free cash flow allowing both for rising cash dividends and a value transfer from net debt to equity inside of enterprise value.

The transition of consumer spending from the physical to the online world is a positive trend, and exceptional businesses with leading ecommerce capabilities are obvious beneficiaries. So are service providers in payments and logistics that facilitate online transactions. The growth in middle class emerging market consumption, in turn, will benefit the luxury, consumer and healthcare sectors. In the latter, we prefer companies that should benefit from emerging market consumers degrading their diet, as western consumers have done over the past 30 years, ‘catching’ many of the ‘diseases of civilisation’, such as diabetes, kidney failure and cancer from excess sugar consumption.

Looking at the energy sector, supply and demand dynamics remain negative, giving scope for the oil price to drift lower, and yet the major oil company stock prices’ are not discounting this in valuations. We also remain negative on European banks as quantitative easing continues to have a highly detrimental impact on net interest margins, loan growth is not yet sufficient to compensate, provisions for loan losses have largely declined already and capital requirements continue to ratchet higher.

With a selective approach taking into consideration the big divergence in prospects across sectors over the next few years, Europe is back on the map for investors worldwide.


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