European equity markets have marginally underperformed their global counterparts. They continue to not look overly appealing from a valuation perspective, although not expensive. Furthermore, there are specific risks facing the continent, Brexit, Italian recession/ debt/ German recession etc.. As a result, it appears the risks outweigh the relative value of the region, particularly for “locally” focussed companies.
Sentiment towards Europe has been soured by the threat of a recession in Germany and a general economic slowdown across the continent. Manufacturing has been particularly hard hit. Fears of a recession have pushed the ECB to act, causing sovereign bond yields to fall, making some long-term yields negative for the first time. This has pushed up the relative attractiveness of equities for Euro based investors, particularly for those stocks that are seen as bond proxies (stable return, quality companies eg. Nestle, Diageo, Unilever).
We have run a slight underweight to European equities for a number of quarters and there does not appear to be a compelling reason to waiver from this at the current time.
As ever, it continues to be difficult to get a strong sense of direction from Japanese equities, however, the market continues to look very cheap relative to other developed market equities and sentiment remains subdued. There is, therefore, scope for a positive surprise although the timing of this is difficult to predict.
Japanese equities are somewhat more sensitive to the fortunes of the global economy than the US and the weakness in growth over the last year goes somewhat to explaining why they are trading at a low valuation. However, given the potential bottoming out in manufacturing that we are now seeing, they could now be set up for a rally.
Japanese equities have been buffeted by the volatility of the US-China trade war, given the entanglement of supply chains and reliance on global growth of many large Japanese companies. However, on the whole the performance of the Japanese market has been strong relative to other developed market equities partially reflecting their cheap valuations.
Asian and emerging market equities have continued to be buffeted by Trump’s trade war tweets. While it is China that is the direct target, the negative sentiment has impacted the region, although some countries are benefitting from shifting supply chains (Vietnam). While the majority of the impact to the underlying companies has so far been on a sentiment basis, there has been some fundamental impact. Nevertheless, the week performance from the region has meant that valuations remain incredibly compelling and there is scope for a significant rally if the global economy recovers and/or trade war concerns moderate.
The inherently higher risk in this market and the current situation mean that we will only apply more aggressive overweights to higher risk portfolios, as we have done previously.