Avoiding short-term traps and finding long-term opportunity in European equities
Portfolio Manager Tom O’Hara outlines the do’s and don’ts of investing in Europe with the prospect of recession and the growing dominance of AI.
4 minute read
Key takeaways:
- It is important for investors to keep focused on the winners over the long term, to build a portfolio fit for the next decade rather than focusing on short-term noise.
- Investors must remember that even quality companies are not immune from sector-specific trends, and it would be wise to keep a finger on the pulse.
- We believe that companies that provide tangible products and services to customers should be able to utilise AI to enhance their proposition.
1. Do not exhaust too much energy worrying about near-term recession
Recession is on everyone’s minds and, try as we might, we are not fortune tellers and cannot tell you the depth, length or timing of any recession. What we do know is that the equity market is a discounting mechanism. We believe that some sectors within the European equity market have already priced in a recession, while others have not. As long-term active managers, we are grateful for market dislocation as it provides us with opportunities.
In the case of Europe, we believe there are select cyclical (economically sensitive) sectors – including oil & gas, materials and chemicals – in which investors have already factored recession into share prices. We also believe that these companies will be crucial going forward as the global economy sees a recalibration of infrastructure and supply chains in a multi-polar, post-COVID and (probably) higher inflation environment. As such, we believe these companies could be beneficiaries of huge capital investment cycles over the next decade. It is important for investors to keep focused on the winners over the long term, to build a portfolio fit for the next decade rather than focusing on short-term noise.
2. Do keep an eye on sector-specific trends
Besides the obvious risk of recession, there are many other factors that one must consider when deciding whether or not to invest in a company. Europe is home to wide array of ‘quality’ companies, but it is important to note that quality does not always guarantee resilient demand in a weaker economic environment. Importantly, quality companies that are facing lower demand might be at risk of de-rating. Attempting to indiscriminately hide in ‘quality’ to avoid the impact of recession can backfire: “out of the frying pan and into the fire”.
For example, spirits businesses in the alcoholic beverages sector has generally long been a successful ‘buy’ for many European active managers over the last decade. Yet today, many of these companies are experiencing a de-rating due to weaker US sales. The stocks are now trading at multi-year relative lows and thus have not provided the “safety in quality” that many investors might have expected. Investors must remember that even quality companies are not immune from sector-specific trends, and it would be wise to keep a finger on the pulse.
3. Do not get carried away with the artificial intelligence (AI) hype
There has been tremendous hype around developments in AI, which has been great for technology and tech-related stocks but not so great for much of the rest of the market. We have already seen many companies punished by market participants who do not believe that such businesses can survive in an AI world (for example IT services, record labels). We do not take such a binary approach to investing, but are conscious of the potential for the AI narrative to de-rate companies without tangible evidence of negative impact.
The truth is that active investors may have to play the waiting game to discover which companies can prove AI as an opportunity rather than a threat. We believe that companies that provide tangible products and services to customers should be able to utilise AI to enhance their proposition. A good example being the capital goods companies, which sell fully automated and digitalised factories; the hardware is still needed, the software gets smarter thanks to AI, so the overall service to clients is improved. Conversely, we’d be nervous about asset-light, software-type businesses given AI has already significantly reduced the replacement cost of such products because fewer humans are now needed to develop the same programmes. Avoiding the losers in this space will be important, but, as ever, focusing on the long-term growth is key.
Capital investment cycle – the purchasing of fixed assets by a company intended to support day-to-day operations. Cyclical – Companies that sell discretionary consumer items, such as cars, or industries highly sensitive to changes in the economy, such as miners. The prices of equities and bonds issued by cyclical companies tend to be strongly affected by ups and downs in the overall economy, when compared to non-cyclical companies. De-rating – de-rating of a stock refers to a negative change in investor sentiment whereby investors are no longer willing to pay a higher price for shares. A de-rating is typically based on investors’ lowered perception of future earnings. Discounting mechanism: stock market participants attach a lower value to a security after considering all available information and events, current and future into their valuations and positioning.
Equity securities are subject to risks including market risk. Returns will fluctuate in response to issuer, political and economic developments.
Technology industries can be significantly affected by obsolescence of existing technology, short product cycles, falling prices and profits, competition from new market entrants, and general economic conditions. A concentrated investment in a single industry could be more volatile than the performance of less concentrated investments and the market as a whole
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.
Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
There is no guarantee that past trends will continue, or forecasts will be realised.
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Specific risks
4 minute read
Key takeaways:
- It is important for investors to keep focused on the winners over the long term, to build a portfolio fit for the next decade rather than focusing on short-term noise.
- Investors must remember that even quality companies are not immune from sector-specific trends, and it would be wise to keep a finger on the pulse.
- We believe that companies that provide tangible products and services to customers should be able to utilise AI to enhance their proposition.
