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Why the value shift favours Europe

John Bennett, Fund Manager of Henderson European Focus Trust, shares his outlook for 2017. He sees the potential for a continued sector rotation as the key factor for European equity investors next year. While he maintains an overall positive outlook, John acknowledges that currency, politics and the chance of deflation are all risks to this view.  

What lessons have you learned from 2016?

Markets are one long enduring learning curve. If a fund manager thinks they have nothing left to learn, then they’re finished, because the market loves to humble. And I think 2016 has been a humbling year for a lot of managers. One or two of our peer group have said exactly the same, that this has been the toughest year I have known. One of the factors that has made it so tough has been the rotation – it’s been a traders’ market. The rotation has been violent because of positioning. The big lesson I learned in 2016 is ‘maybe you didn’t look at positioning enough’. First we had the rally in energy, then mining; two areas that many people had found easy to avoid for a number of years. And more recently in the US we had ‘the big one’, and thankfully this we did manage to be on the right side of. It’s unusual for us to like the banking sector, but we managed to pre-position for that. And that was through applying the lesson we learned about positioning.

What are the key themes likely to shape the markets in which you invest in 2017?

I think the key influences going into 2017 will be whether we’re right on equities moving from a growth to value market on a global basis. Growth stocks are those companies whose earnings are expected to grow faster than the broader market, whereas value stocks are those the fund manager believes are trading below their intrinsic worth. It’s been a one-way growth market since the financial crisis – you haven’t wanted to be in value. I’m not a great fan of those labels (growth versus value), as these things are in the eye of the beholder. But I do think that we are running out of road on quantitative easing (QE) – central bankers know this – and that will shape markets. I therefore believe we have touched the lows on bond yields globally, and the valuation high water-mark for bond proxies (defensive, low volatility, high yielding equities that mirror bond-like characteristics) – stocks that have been ‘oh-so-comfortable’ to be in. In October and November it became very uncomfortable to be in those stocks, and I think this is a move that has only just begun. To be right on that, I’ve got to be right on one thing; that deflation doesn’t win, and that therefore bond yields have got further to go up (or certainly not going down). However if deflation does win, and bond yields go further down, I will be wrong on being in value stocks; you would’ve wanted growth. But growth has been the last decade; I believe value will be the next.

What are your highest conviction positions moving towards the new year?

I think if you have ‘high conviction’ at the end of 2016 you’re a strange person, or you’ve got a stronger constitution than I have. I’ve always said, be aware of the fund manager who’s got high conviction on everything at all times – that’s quite a dangerous beast in my view. A dose of humility and neurosis is always welcome.

So, I go into 2017 shaken by some of the events of 2016. But where I do have conviction is in the view that we are moving from a growth to a value market. One of the reasons I don’t describe my view as ‘high conviction’ is not just because of the events of 2016 and how tough it has been for active managers, but because the most important sector as we move into 2017 is something I have not liked for the past decade – financials.

What should investors expect from your asset class and your portfolio(s) going forward?

There’s a whole interplay of things. I think currency is important. If we get a strong dollar it is usually good for European equities, and less good for emerging market equities. If I’m right that we’re moving from a growth to value market, I think this can knock on the head US equity outperformance versus other parts of the world. The value markets of the world are more Europe and Japan than they are the US, just by the nature of indices. So I think there might be an asset allocation shift to come. The thing that holds me back from having ‘high conviction’ is that the political upheavals that we’ve seen – Brexit, Trump – are moving now to Europe, and that will be a whole lot trickier as it’s not one nation, it’s a currency bloc. I think you could easily see the wobbles come back on the periphery in the form of the euro, and that political risk holds me back from saying that relative to the US, Europe is now a ‘buy’. But, we will get through that political risk, and that is what might create the opportunity to buy Europe. European equities have seen big outflows this last year, and this gives me much more optimism. I was not that positive on markets going into 2016; I’m much more so for 2017.

What are the main risks?

In pure market direction terms, if the US raises interest rates and the market doesn’t like it and falls, say 10%, then Europe isn’t going up.

Beta traditionally measures the outsized reaction of a stock relative to its market, so a high beta – where it’s greater than one - would point to a stock that outperforms its market on the way up, but conversely underperforms on the way down. Europe is effectively quite a high beta play on the US, especially on the way down. That would be the near-term risk to direction. The other is the Chinese renminbi devaluation, which is ongoing and not getting air time. If that comes back to centre page, that could be a risk to market direction.

The risk to Europe experiencing a change in market leadership is bond yields going to new lows i.e. the deflation argument keeps winning. That would knock on the head any renaissance of value.

John Bennett is Director of European Equities at Henderson Global Investors and manages £9.4bn across a number of European mandates. 

He constructs his portfolios utilising a blend of top-down analysis - which observes macro-economic factors and over-arching sector trends - and bottom-up stock-picking. 

When it comes to selecting his investments John is a style agnostic, which means he doesn’t pin his flag to the mast and invest with any one style at any period of time, for example growth which looks for companies with above average levels of earnings growth, or value which looks for companies that the market has intrinsically undervalued. 

He also runs a focused list, meaning his portfolio will generally contain between 50 and 60 companies, and will buy all sizes of businesses but mainly focuses on mid and large. 

Before investing in an investment trust referred to in this document, you should satisfy yourself as to its suitability and the risks involved, you may wish to consult a financial adviser.
The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
Nothing in this document is intended to or should be construed as advice.  This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.
Issued in the UK by Henderson Investment Funds Limited (reg. no. 2678531), incorporated and registered in England and Wales with registered office at 201 Bishopsgate, London EC2M 3AE, and authorised and regulated by the Financial Conduct Authority to provide investment products and services. 
 
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