Brexit uncertainty has captured the headlines, but we are constructive on quality growth holdings
For months, Europe has grappled with geopolitical uncertainty in the form of ongoing Brexit negotiations (which face a looming March 2019 deadline) and Italy’s populist coalition government. In this environment, UK companies have appeared less likely to invest — which could lead to lower European growth levels next year.
So what do Brexit doubts mean for our team’s Earnings, Quality, Valuation (EQV) outlook for the UK and eurozone? Let’s begin by dispelling three myths about the area.
Three myths about Europe
1. Myth 1: Europe always underperforms the US.
In dollar terms, European equities have outperformed the S&P 500 Index in eight of the last 15 calendar years1 — they just haven’t done so recently. But we believe there are growth opportunities on the horizon. European gross domestic product (GDP) is trending at a 2.3% rate for the year,2 which isn’t all that bad for a region that has struggled with growth of late. The market has reacted negatively to the recent decline in Eurozone Manufacturing PMI (which fell to 53.23 in the third quarter after peaking in the fourth quarter of 2017), and growth is no longer accelerating. However, broader economic sentiment indicators such as business confidence put Europe in position to grow close to 2% next year.4 And, although eurozone growth has moderated, it is still near a decade high. The Invesco International and Global Growth team feels expectations are fairly low.
2. Myth 2: European earnings are not growing as fast as the rest of the world.
Since the trough in March 2009, European earnings have only grown at half the rate of the US. However, when we look toward 2019, consensus expectations project close to 10% earnings growth, similar to developed markets. After witnessing years of underinvestment, we expect European companies to invest in new capital equipment with capacity utilization close to a peak, which we believe will benefit growth.
3. Myth 3: Italy will leave the euro and put the currency union in jeopardy.
Indeed, the Italian coalition government has upset the markets and undermined the EU by tripling the targeted budget deficit to 2.4% for 2019 — despite debt/GDP (at around 131%) being the second-highest in Europe after Greece. 5 However, the reality is that over 60% of citizens support the euro in Italy,6 so we feel the risk of Italy leaving the euro is over-exaggerated.
Where are we seeing opportunity?
So, what do Brexit concerns mean for our bottom-up EQV approach? Our UK holdings in the Invesco International Growth Fund and the Invesco European Growth Fund feature large, international businesses with average UK exposure of no more than 10% (as of Sept. 30, 2018).
With regard to positioning, we remain overweight financials, as they are relatively inexpensive and we are well-diversified within the space. We believe the expected end of European Central Bank quantitative easing next year, along with still-decent growth and high capital levels, should provide our financials with a good risk-reward balance.
In the third quarter, we also initiated positions in two large-cap European holdings, TechnipFMC and Finecobank.
- TechnipFMC, a merger between French Technip and American FMC, is a well-managed oilfield service company with market-leading positions (0.94% weight in Invesco International Growth Fund and 0.94% weight in International European Growth Fund as of Sept. 30, 2018). After a difficult few years for the industry, we are slowly seeing new contract bookings, and while the order backlog is 54% below prior its peak, it is up 15% since the end of last year, as of June With earnings at or near cycle lows, we believe the company may benefit over the next few years as demand returns and as it delivers on cost-cutting synergies. The balance sheet is strong with no debt, and the shares are very inexpensive on mid-cycle earnings, in our view.
- Finecobank is an Italian high-growth, high-return multi-channel bank, asset manager and brokerage business (0.67% weight in Invesco International Growth Fund and 0.66% weight in International European Growth Fund as of Sept. 30, 2018). Its market share of 1.6% is poised to ramp up based on the company’s superior digital platform versus other banks, in our view. Returns are very attractive, in our view, with a return on equity of over 30% and a strong balance sheet. The short-term valuation is not inexpensive at 21 times the 2019 price-earnings (P/E) ratio — but on a three-year view, valuation is closer to 15 times P/E, which we believe will prove to be a good entry price.
The bottom line
In conclusion, we feel that in a momentum-driven market that reminds us of the late 1990s, there is a stronger-than-normal need to have confidence in short-term earnings, even though our approach looks three to five years ahead. We are witnessing more dramatic moves when shares of companies slightly miss expectations. In an environment where US earnings growth might be peaking, we believe our quality growth style might be moving back into favor as companies with higher-than-normal earnings visibility, margin stability, strong returns and balance sheets have recently started to outperform.
Learn more about Invesco International Growth Fund and Invesco European Growth Fund.
1 Source: FactSet Research Systems, Inc. European equites are represented by the MSCI Europe Index. Past performance does not guarantee future results. An investment cannot be made in an index.
2 Bloomberg L.P. as of Sept. 30
3 Source: Bloomberg L.P. as of Sept. 30
4 Source: IMF as of Sept. 30
5 Source: Financial Times
6 Source: Eurobarometer
Important information
Blog header image: supergenijalac/Shutterstock.com
The MSCI Europe Index is an unmanaged index considered representative of European stocks. The index is computed using the net return, which withholds applicable taxes for non-resident investors.
Invesco International Growth Fund Risks
Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.
Stocks of medium-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.
The Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the Fund.
Invesco European Growth Fund Risks
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.
Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested.
Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.
The Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the Fund.
Richard Nield, CFA
Senior Portfolio Manager
Richard Nield is a Senior Portfolio Manager with the Invesco International and Global Growth team, focusing on large and mid-cap equities in Europe, Canada, the Middle East and Africa. Mr. Nield is a co-manager of the Invesco International Growth and Invesco European Growth strategies.
Mr. Nield joined Invesco in 2000 as an equities analyst on the International and Global Growth team and was promoted to portfolio manager in 2003. He assumed his current role in 2015. Prior to joining Invesco, Mr. Nield worked as a senior analyst with Ontario Teacher’s Pension and with Ontario Municipal Employees Retirement Systems (OMERS). He began his investment management career in 1995 as an investment advisor with RBC Dominion Securities.
A native of Toronto, Canada, Mr. Nield earned a Bachelor of Commerce degree in finance and international business from McGill University in Montreal. He is a CFA charterholder.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial advisor/financial consultant before making any investment decisions. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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