The end of 2015 didn’t bring any dramatic changes to European fundamentals. However, there have been some subtle shifts that the Invesco International and Global Growth team is keeping an eye on in 2016. While we didn’t initiate any new European positions in the Invesco International Growth strategy during the fourth quarter of 2015, recent volatility has brought some of the names on our “watch list” closer to the point where we would add them to the portfolio.
The long-term economic impact of Germany’s migrants remains unclear
There is some uncertainty as to how the influx of one million migrants will affect Germany, both politically and economically. Politically, Chancellor Angela Merkel’s approval rating, which had been stable for years at approximately 70%, has fallen to around 50%† over fears the migration crisis and terrorist threat are tied together. The market will be concerned if there is any indication she might not win another term. She has a year and a half to fix the problem before the next national elections.
Economically, the influx of migrants may act as a short-term tailwind to German gross domestic product, potentially to the tune of a 0.5% increase. However, the medium- and long-term effects are less clear and will depend on how quickly the newcomers can be integrated into German society. Elsewhere on the economic front, we have seen companies in sectors such as autos and engineering tumble on export concerns, as Germany has the highest exposure to China among European countries.
Fears of a “Brexit” continue in the United Kingdom
Fears of a “Brexit” (a British exit from the European Union) remain a concern in 2016 as this could cause more splintering in the region. Also, the pound sterling has depreciated to 2009 lows as the Bank of England reversed its tone and, unlike the Richard Nield Senior Portfolio Manager, Invesco International and Global Growth team www.invesco.ca U.S. Federal Reserve that has begun raising rates, pushed out any thoughts of an interest-rate hike on evidence U.K. economic indicators are slowing.
Fortunately, our U.K. exposure within the Invesco International Growth strategy has been relatively defensive. We continue to overweight the U.K. versus our benchmark because of the strong defensive growth characteristics of our holdings there. On the other hand, in Continental Europe it has been more difficult to find new companies that have valuations attractive enough to be included in our strategy.
Volatility has made certain names more attractive
When we examine how our European positions look under our “EQV” (Earnings, Quality and Valuation) criteria, it is clear that earnings fundamentals have regressed in the past three to six months. We are seeing consistent earnings downgrades based on slowing global growth. In our view, there are two traits that help our strategy in times like these:
- Our aversion to companies with high debt loads
- Our focus on high-quality, cash-generative business models
We continually keep an updated watch list of intriguing names, and during times of market stress we look to add new high-quality growth companies to the portfolio. The good news is that the market correction in early 2016 has brought some of the names on our watch list closer to the point where we would add them to the portfolio. These include high-quality cyclical stocks in the spirits, financials and capital goods sectors. Conversely, most low-quality cyclicals and defensive sectors, such as consumer staples and health care, look rich. We did not invest in any new companies in the Invesco International Growth strategy in the fourth quarter of 2015 as we remain disciplined with our entry points.
Overall, it is fair to say that the European region has seen a slight slowing of growth sequentially, but not enough to change our current view and positioning. We still see better fundamentals in companies that depend on international markets to balance out growth opportunities.
- One example is Unilever N.V. (0.83% of Invesco International Growth Class, 1.16% of Invesco European Growth Class and 0.75% of Invesco Global Growth Class as at December 31, 2015), a multinational consumer goods company that reported strong fourth-quarter results. The company, co-headquartered in the Netherlands and the U.K., is gaining share in Europe, but the Americas and Asia-Pacific are where it continues to see the best growth, helped by its innovation program and strong distribution platform
- Another example is German software giant SAP SE (1.61% of Invesco International Growth Class, 1.68% of Invesco European Growth Class and 0.90% of Invesco Global Growth Class as at December 31, 2015), which delivered another strong quarter led by its Cloud software business that is enabling it to take market share from the competition. SAP is seeing solid growth in most markets because of its competitive positioning