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Market watch

European equities: outlook is increasingly optimistic

Issue date: 2021-03-31

FIL Limited

 

Market overview

European equities delivered positive returns in February 2021 and turned around the downtrend in January resulted from heightened pandemic worries. The roll-out of COVID-19 vaccines, hopes for additional fiscal stimulus in the US, strong corporate earnings and improving economic data buoyed equities, despite a rise in bond yields triggered by higher inflation expectations.
 

European companies delivered very strong results for the last quarter of 2020, with a record share of companies beating earnings estimates. In addition, estimates for 2021 and 2022 were upgraded in aggregate. European Central Bank (ECB) has indicated that it will speed up its emergency bond purchases to counter the sell-off in eurozone’s sovereign debt markets if borrowing costs continue to rise. 

The roadmap out of lockdown measures is becoming clearer across the region; Germany plans to extend its lockdown until mid-March on concerns over new strains of the virus, but will gradually start reopening in the coming weeks, while UK Prime Minister Boris Johnson has unveiled a plan to gradually begin lifting restrictions from 8 March. 

Growth and defensive names underperformed on increasing optimism over an economic recovery. At a sector level, financials and energy were the key performers. Conversely, defensive sectors such as utilities, consumer staples and health care declined the most (Chart 1).

The markets have recently witnessed a rotation into financials and energy stocks. However, we remain sceptical of these sectors over the longer term as many of these “value” plays face structural headwinds. Banks for example not only continue to struggle with low interest rates, but also face increasing competitive pressure from Fintechs that are eroding their economic moats and earnings power. Similarly, fossil fuel-based energy companies are likely to face a long decline in demand, which will have lasting impact on these companies’ ability to generate earnings and cashflows. 

Chart 1: Cyclicals outperformed defensives in a risk on environment

Source: DataStream, as at 28 February 2021.

Outlook

The outlook for European equities appears increasingly optimistic, as the roll-out of vaccines has begun to facilitate a roadmap for the reopening of European economies. However, we remain cautious on the timing of any recovery, particularly as new, more transmissible variants of the virus circulate, and as vaccination rollout across countries is progressing at varying rates. Markets appear to already have priced in much of the recovery, leaving them vulnerable to any disappointment. Further, with renewed concerns about inflation, credit conditions appear to be tightening in Europe. However, the ECB’s flexibility with its Pandemic Emergency Purchase Programme (PEPP) to prevent any tightening of financial conditions is supportive. We expect the ECB to retain its extremely accommodative monetary policy, focussing on maintaining loose financial conditions. The central bank is also likely to spend the PEPP package fully and ease policy further via other tools in coming months. 

In this uncertain environment, investors should seek to invest in companies that will thrive over the long term regardless of the macro backdrop. In terms of risks, investors are advised to avoid companies that have taken on high levels of debt. Many firms have taken advantage of the decade-long low interest rate environment to finance their growth and therefore entered the crisis with over-levered balance sheets. Whilst governments have proven supportive of businesses and consumers across Europe, the real economic recovery remains uncertain and much of the pain may have been deferred rather than averted. 

IMPORTANT INFORMATION

FIL Limited and its subsidiaries are commonly referred to as Fidelity or Fidelity International. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. Any person considering an investment should seek independent advice.

Investment involves risks. This material contains general information only. It is not an invitation to subscribe for shares in a fund nor is it to be construed as an offer to buy or sell any financial instruments. The information contained in this material is only accurate on the date such information is published on this material. Opinions or forecasts contained herein are subject to change without prior notice. Reference to specific securities mentioned within this material (if any) is for illustrative purpose only and should not be construed as a recommendation to the investor to buy or sell the same. 

The material is issued by FIL Investment Management (Hong Kong) Limited and it has not been reviewed by the Securities and Futures Commission (“SFC”).



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