23 Nov 2021
Portfolio Manager Ken Hsia discusses how increasing headwinds and unpredictability should be expected as Europe normalises post-pandemic.
With all those headlines, we might have expected more volatility from regional stocks. Yet markets are at their all-time highs and 60% above the March 2020 pandemic lows. While Europe has benefitted from exceptional levels of stimulus, in GDP terms many of its economies have not yet normalised and in some cases are only now approaching 2019 levels of output.
Almost certainly, there will be more unpredictability. With markets at new peaks, and trading on 16x price-earnings multiples versus a long-term average of 14x, we are now meeting some headwinds. Supply chains are an obvious one, but these are being fixed, and in retrospect, I don’t think they will be regarded as significant. More important are rising energy prices, leading to higher inflation. This could be an issue as Europe is a net importer of oil, gas and other energy sources.
While rising energy prices offer a tailwind for the producers, that reverses for companies where energy is a large cost component - we are not exposed to airlines, for example. Elsewhere, we are overweight banks as they are set to benefit from loan growth currently at higher levels than at any time over the past decade, while a normalising interest rate environment means lending margins should also expand. Valuations here do not yet reflect the more attractive outlook, especially on a 10-year view.
We are pro-cyclical, which means that we try and maintain a balanced portfolio, keeping our beta close to one. Apart from banks, we are also overweight consumer discretionary, where the pandemic induced closing and reopening of economies has resulted in very mixed earnings momentum and led to a derating for some e-commerce retailers. We believe this is a structurally growing sector.
Against the backdrop of rising inflation, we are also exposed to sectors with pricing power, which enhances the quality of returns over a cycle. This includes paper and packaging, and even steel, where China’s policy of reducing exports reverses its trend of flooding the rest of the world with cheap steel, which should have positive pricing dynamics.
Our underweights include lower beta sectors, which had benefitted from the low interest rate environment, but will now face increasingly negative operating dynamics. This includes healthcare and consumer staples, where raw material price inflation is pressuring margins.
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All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests.
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With Western central-bank policy normalising, economic growth rates diverging and global trade still readjusting to life after lockdown, investors have a complex environment to navigate in 2022.
Ninety One’s portfolio managers assess the outlook across their asset classes and regions.
Our team also takes a deep dive into the outlook for emerging markets, as well as into how sustainability will drive investment outcomes next year and beyond.