Why I'm backing a consumer comeback in Europe
July 2, 2019

James Sym, European Equities Fund Manager at Schroders, comments on why the European outlook may be less gloomy than investors think.

Worries over slowing global growth and rising trade tensions hit European share prices hard at the end of 2018. While early 2019 saw a rally, there remains considerable scepticism over the prospects for the European economy and its listed companies.

I think much of this scepticism is misplaced and the role of the European consumer is an important reason why.

Household spending drives around 70 percent of the US economy. It's a lesser share in Europe – more like 45-50 percent depending on the country – but that's still a very sizeable proportion. And, for the first time in around a decade, the European consumer is in a much better place. Official data tells us that the picture is improving, and my own experience of talking to companies bears that out too.

Wages are rising in Europe

I meet around 300 companies a year. Two years ago when I asked them about wage rises they said 1-2 percent was standard; now it's 3-4 percent. For niche areas demanding specific skills it can be considerably more; if you want to hire a German software engineer it's probably 8-10 percent. In aggregate, we are seeing much better wage rises in Europe.

Meanwhile, inflation is relatively well-behaved (annualized inflation in the eurozone was 1.2 percent in May 2019). What this means is that consumers have more money in their pockets.

Some of this increase in wages can be attributed to minimum wage rises. Years of austerity after the global financial crisis are now finally coming to an end. As of April, the UK increased the minimum wage for over-25s by 4.9 percent. Spain's minimum wage jumped by 22 percent in January.

Governments are loosening the purse strings

Clearly, the pressure applied by movements such as the "gilets jaunes" in France is having some effect. It's also reflected by the government in Italy, for example, where we have seen the populist coalition rebel against the EU's budget deficit limits.

For the first time in a number of years, European governments are spending a little bit more today than they spent yesterday. Governments make up between 40-50 percent of the average European economy so a boost of 0.5 percent, say, is a big stimulus if the economy in total is only growing by 1 percent to 1.5 percent. This could be very important in terms of internal demand accelerating in Europe.

Consumer cyclicals poised to benefit

The question for me as a fund manager is: which parts of the market are poised to benefit from this reacceleration? The cheapest style grouping in the European stock market at the moment is consumer cyclicals. Consumer cyclicals are in industries such as car manufacturing, leisure vehicles, entertainment and retailers.

These stocks are out of favour because investors think the economic cycle has already peaked for such companies. But this part of the market could be a fruitful hunting ground for stockpickers, given the improved environment for the consumer mentioned above.

Another area that looks interesting is financials. Interest rates remain at ultra-low levels in Europe and this has dissuaded investors from looking at the banking sector. But I would argue that interest rates do not need to rise for banks, or certain banks at least, to prove a worthwhile investment.

There are well run, strongly capitalized banks offering attractive dividend yields in many countries in Europe. Some banks, notably several in Italy, remain a high risk investment but there are many others that could prove resilient, even in the event of an economic slowdown.

Trade wars remain a risk

Clearly, a slowdown remains a worry. Trade wars are a concern with China being Europe's most important export market.

Meanwhile, many industrial companies have to spend more to increase capacity, given that little capacity has been added since the global financial crisis and demand has slowly been recovering. The need to spend on extra capacity squeezes their profit margins and is one reason why we do not see industrial cyclicals (such as capital goods companies) as a particularly attractive grouping right now.

Another reason is that valuations in this part of the market have largely recovered after falling at the end of last year.

Europe as a whole is unloved by investors, particularly consumer stocks and banks. But, to my mind, it doesn't make sense to chase those areas of the market that have already gone up in value.

Instead, the opportunity lies in taking a contrarian view and seeking out parts of the market that have lagged but where there is scope for improvement. As ever though, it's crucial to be selective and find the individual stocks with the most attractive risk/reward profile.





This site, like many others, uses small files called cookies to customize your experience. Cookies appear to be blocked on this browser. Please consider allowing cookies so that you can enjoy more content across fundservices.net.

How do I enable cookies in my browser?

Internet Explorer
1. Click the Tools button (or press ALT and T on the keyboard), and then click Internet Options.
2. Click the Privacy tab
3. Move the slider away from 'Block all cookies' to a setting you're comfortable with.

Firefox
1. At the top of the Firefox window, click on the Tools menu and select Options...
2. Select the Privacy panel.
3. Set Firefox will: to Use custom settings for history.
4. Make sure Accept cookies from sites is selected.

Safari Browser
1. Click Safari icon in Menu Bar
2. Click Preferences (gear icon)
3. Click Security icon
4. Accept cookies: select Radio button "only from sites I visit"

Chrome
1. Click the menu icon to the right of the address bar (looks like 3 lines)
2. Click Settings
3. Click the "Show advanced settings" tab at the bottom
4. Click the "Content settings..." button in the Privacy section
5. At the top under Cookies make sure it is set to "Allow local data to be set (recommended)"

Opera
1. Click the red O button in the upper left hand corner
2. Select Settings -> Preferences
3. Select the Advanced Tab
4. Select Cookies in the list on the left side
5. Set it to "Accept cookies" or "Accept cookies only from the sites I visit"
6. Click OK

James Sym, European Equities Fund Manager at Schroders, comments on why the European outlook may be less gloomy than investors think.

Worries over slowing global growth and rising trade tensions hit European share prices hard at the end of 2018. While early 2019 saw a rally, there remains considerable scepticism over the prospects for the European economy and its listed companies.

I think much of this scepticism is misplaced and the role of the European consumer is an important reason why.

Household spending drives around 70 percent of the US economy. It's a lesser share in Europe – more like 45-50 percent depending on the country – but that's still a very sizeable proportion. And, for the first time in around a decade, the European consumer is in a much better place. Official data tells us that the picture is improving, and my own experience of talking to companies bears that out too.

Wages are rising in Europe

I meet around 300 companies a year. Two years ago when I asked them about wage rises they said 1-2 percent was standard; now it's 3-4 percent. For niche areas demanding specific skills it can be considerably more; if you want to hire a German software engineer it's probably 8-10 percent. In aggregate, we are seeing much better wage rises in Europe.

Meanwhile, inflation is relatively well-behaved (annualized inflation in the eurozone was 1.2 percent in May 2019). What this means is that consumers have more money in their pockets.

Some of this increase in wages can be attributed to minimum wage rises. Years of austerity after the global financial crisis are now finally coming to an end. As of April, the UK increased the minimum wage for over-25s by 4.9 percent. Spain's minimum wage jumped by 22 percent in January.

Governments are loosening the purse strings

Clearly, the pressure applied by movements such as the "gilets jaunes" in France is having some effect. It's also reflected by the government in Italy, for example, where we have seen the populist coalition rebel against the EU's budget deficit limits.

For the first time in a number of years, European governments are spending a little bit more today than they spent yesterday. Governments make up between 40-50 percent of the average European economy so a boost of 0.5 percent, say, is a big stimulus if the economy in total is only growing by 1 percent to 1.5 percent. This could be very important in terms of internal demand accelerating in Europe.

Consumer cyclicals poised to benefit

The question for me as a fund manager is: which parts of the market are poised to benefit from this reacceleration? The cheapest style grouping in the European stock market at the moment is consumer cyclicals. Consumer cyclicals are in industries such as car manufacturing, leisure vehicles, entertainment and retailers.

These stocks are out of favour because investors think the economic cycle has already peaked for such companies. But this part of the market could be a fruitful hunting ground for stockpickers, given the improved environment for the consumer mentioned above.

Another area that looks interesting is financials. Interest rates remain at ultra-low levels in Europe and this has dissuaded investors from looking at the banking sector. But I would argue that interest rates do not need to rise for banks, or certain banks at least, to prove a worthwhile investment.

There are well run, strongly capitalized banks offering attractive dividend yields in many countries in Europe. Some banks, notably several in Italy, remain a high risk investment but there are many others that could prove resilient, even in the event of an economic slowdown.

Trade wars remain a risk

Clearly, a slowdown remains a worry. Trade wars are a concern with China being Europe's most important export market.

Meanwhile, many industrial companies have to spend more to increase capacity, given that little capacity has been added since the global financial crisis and demand has slowly been recovering. The need to spend on extra capacity squeezes their profit margins and is one reason why we do not see industrial cyclicals (such as capital goods companies) as a particularly attractive grouping right now.

Another reason is that valuations in this part of the market have largely recovered after falling at the end of last year.

Europe as a whole is unloved by investors, particularly consumer stocks and banks. But, to my mind, it doesn't make sense to chase those areas of the market that have already gone up in value.

Instead, the opportunity lies in taking a contrarian view and seeking out parts of the market that have lagged but where there is scope for improvement. As ever though, it's crucial to be selective and find the individual stocks with the most attractive risk/reward profile.



Free subscription - selected news and optional newsletter
Premium subscription
  • All latest news
  • Latest special reports
  • Your choice of newsletter timing and topics
Full-access magazine subscription
  • 7-year archive of news
  • All past special reports
  • Newsletter with your choice of timing and topics
  • Access to more content across the site

More on:  Market commentary