PERSPECTIVES
JUNE 2016
This is for investment professionals only and should not be relied upon by private investors
Europe Beyond Brexit
Paras Anand, Head of European equities, gives his reaction to Brexit and
answers questions on the implications of the UK’s decision to leave the EU.
Paras believes that market declines make European equity valuations
attractive, especially since political events like these tend to affect
companies only at the margin. Continued indiscriminate volatility will allow
research-driven investors to buy robust franchises at cheap valuations.
A surprising late swing for the leave vote
The UK’s EU referendum result (51.9% leave: 48.1% remain) was a surprise
result for financial markets. Sterling had rallied earlier in the week, having been
encouraged by polls which suggested a vote to remain was likely. Despite the
pre-vote rally, the market’s strong negative reaction may prove too pessimistic.
History shows that the impact on economies and companies from political events
often tends to be more manageable than initial gloomy forecasts suggest. The UK
and European corporate sectors are actually international in nature (see chart 1).
If you look at the US corporate sector, it very much faces off the domestic
economy; the Asian corporate sector likewise earns most of its revenues from
Asia. The UK and European corporate sectors are much more diversified.
Chart 1 UK and European revenues are diverse within equity markets
FTSE 100
MSCI Asia Pacific ex Japan
UK
20.4%
26.0%
28.4%
24.7%
1.5%
5.1%
10.7%
Europe ex UK
Americas
Europe ex UK
82.5%
Americas
Asia
MSCI Europe
UK
Asia
S & P 500
3.0%
17.6%12.3%
UK
14.0% 13.6%
Europe ex UK
Europe ex UK
28.2% 41.2%
Americas
Asia
UK
68.9%
Americas
Asia
Source: Fidelity International, FactSet, June 2016.
Paras Anand joined Fidelity as
Head of Pan-European Equities in
January 2012. In this role he leads
and manages 28 Portfolio Managers
and five Investment Directors; he is
also responsible for the
development of Fidelity’s equity
income capability.
Previously, he was a portfolio
manager, team leader and Head of
European Equities at F&C, and prior
to that was head of Deutsche Asset
Management’s European equities
team in New York. He has also
worked at HSBC Alternative
Investments, managing a UK market
neutral hedge fund, and at GT
Investments (latterly Invesco). Will today’s market reactions prove to be long lasting?
This reaction is likely to be short-lived as, in my view, this is a political event that
will have less of an economic impact than markets are discounting. I think this
referendum will prove to be more modest in its effect than the financial crisis or
the sovereign debt crisis.
Will the Brexit vote lead to higher interest rates and an
increase in inflation?
Inflation was already looking as if would rise somewhat given the increase in the
oil price so far this year. Add in the inflationary impact of a much weaker sterling
and there is an increased chance that the consensus view that rates will stay low
(or go lower) and sterling will remain weak for a prolonged period could prove too
pessimistic a scenario.
What will be the impact of David Cameron’s resignation?
Political instability is unnerving but political risk was already rising. Such instability
matters less once a government starts to lose a convincing mandate as the
private sector starts to take on the greater burden of investment. This can be
positive for markets as the private sector tends to allocate capital on the basis of
earning a financial return whereas governments tend to allocate capital on the
basis of earning a political return.
Why should investors own European equities?
The reasons are grounded in attractive valuations with European equities trading
at a 2016 forward price-to-earnings (PE) ratio of about 16x and a 4% prospective
dividend yield. When comparing equities with bonds, it is worth noting that over
70% of European companies now have dividend yields higher than their
corporate bond yields. Yield-hungry investors will increasingly be tempted by a
combination of higher dividend yields and robust business franchises.
Where are the opportunities in Europe?
Healthcare companies and high-quality banks look interesting. Within the
healthcare sector, there are companies trading at valuations last seen when there
was perceived to be a widespread patent risk and a serious threat from generic
manufacturers. Within the banking sector, there are good prospects for attractive
dividend payments and total shareholder returns in select stocks.
And in the UK?
There are many potential winners with the leading contenders being international
companies based in the UK - in the event that sterling remains weak these
companies will accrue a competitive advantage.
Thereafter, there may well be opportunities in domestic companies with
particularly strong franchises as they will have an opportunity to strengthen their
market positions should trading environments become tougher.
Fundamentally, what our portfolio managers are doing post-Brexit is no different
to what they are looking to do every day. It is still about using the opportunities
that arise from short term macro-economic events to buy companies that we want
to own for the longer term.
PERSPECTIVES | Europe Beyond Brexit
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