European shares are cheap: time to get greedy?
Investors retreated from European stocks throughout 2016, with market sentiment close to its lowest level since the 2011-2012 sovereign debt crisis. Then, as now, political and macroeconomic uncertainty is the primary source of anxiety.
Amid continued economic torpor, a range of political pressures - including Brexit, the rise of anti-establishment movements that threaten the European construct, and social tensions caused by the migrant crisis - spurred investors to pull up to €100 billion (£85 billion) from European equity funds in 2016.
Founded on either economic, political or policy concerns, we see scepticism and fear as signals of opportunity. European companies will continue to adapt over the next four years, forging their own destiny in spite of regional misery. Investors who recognise this will be in the minority, and they are likely to be rewarded.
POLITICS IS NOT THE MARKET
The political stage is not the market, and the corresponding risk needs to be weighted accordingly. We don't trivialise political risk, but prefer to base our assessment of potential stock performance on analysis of the underlying company.
It is easy to overestimate the impact of political events. Moreover, even calling the outcome of an election correctly is no guarantee of success.
Investors that predicted the UK's vote for Brexit may have briefly been in the money, but unless they were nimble enough to take profits in the days immediately afterwards they would have subsequently surrendered those gains and more.
Many were worried about what the election of Donald Trump meant for markets, but the enthusiastic response from US equity markets confounded the sceptics.
While it is too early to tell what a Donald Trump Presidency may bring, it is worth remembering that many investors were fearful when Ronald Reagan, a former Hollywood actor, was elected in 1980.
Anyone who sold out of the US equity market at that time would have missed the subsequent doubling of the S&P 500 over his presidency, a period which included Black Monday.
EUROPE: LAND OF OPPORTUNITY
We believe investors need to focus on what is happening on the ground.
Companies are not the economy or the politics of any nation, and though European businesses may operate within these overarching forces, many have the talent, resources, and opportunities to adapt, restructure and innovate in order to thrive.
One feature of Europe that the bears need to keep in mind is that most companies have already endured eight years of economic and political turbulence. Their concerns today are similar in nature to those in 2008 and 2012.
The verse may have changed but the song remains the same. European markets are cheap, full of companies that have been forced to innovate to drive organic growth, and to drive down costs and boost efficiency to accelerate earnings.
When it comes to innovation and efficiency, technology remains critical for almost every stock and sector in the market.
Whether it's retailers enhancing their online sales channels, banks overhauling legacy IT systems or mega-cap pharmaceutical companies protecting themselves from cyber threats, it is imperative that companies harness the productivity-enhancing catalyst that is technological change.
A prime example is Madrid-based Amadeus, an IT solutions provider to the travel industry, whose Altea software enables airlines, hoteliers and others to manage their capacity, pricing and costs more effectively.
Another is London-based Autotrader, an online vehicle classifieds service, which has grown in popularity by lowering marketing costs for car dealerships.
In fact, its emergence as the primary portal for used cars has made the second-hand car industry more efficient.
TIME TO GET GREEDY?
In the absence of an economic tailwind, successful companies develop value-added products and services, establish efficient cost bases, and build robust balance sheets.
Investors who are disheartened by political risk miss these opportunities.
In this environment, we need to remember Warren Buffet's advice - 'you want to be greedy when others are fearful'.
As the market focuses on the enduring economic and political problems in Europe, opportunities for bottom-up, active investors to identify resourceful, innovative, and growing companies will persist.
Martin Todd is a European equities portfolio manager at Hermes Investment Management.