We’ve all heard the adage, “Sell in May and go away.” It’s often used by investors who believe that equity markets decline or at best tread water in the summer months and don’t have attractive prospects for moving upwards until the autumn. We, however, beg to disagree. Indeed, as long-term investors, we believe it’s important to remain fully invested throughout a market cycle to benefit fully from exposure to risk assets such as equities. Furthermore, we think there are several opportunities in the current environment that investors might seek to explore. One such example is Europe.
The long-term outlook for Europe is looking far brighter than it did a year ago. Political tail risk is draining away in the wake of the Dutch and French elections, while Prime Minister Theresa May’s decision to hold a snap election should put her in a stronger position at home ahead of the Brexit negotiations beginning in earnest. In addition, the rise of another centrist candidate in Germany, Martin Schulz, eases the possibility of an anti-European outcome in Germany, while Greece has, to date at least, managed to avoid any financial blow-ups, even though long-term issues remain. Elsewhere, in terms of geopolitical risks, fears that the new US administration’s policies might negatively impact global trade are also receding.
It’s all in the numbers
The fact is that, once you get away from the politics, recent short-term data in Europe are looking very encouraging. For example, key leading indicators, including recent PMI figures, are very strong, business confidence has rebounded and credit growth is robust. Indeed, the corporate operating environment is much improved. First quarter corporate earnings are up strongly and, most importantly, top-line revenue growth has risen nearly 10 per cent. Against this backdrop, the recent first quarter GDP print for the Euro area showed that the economy had grown 0.5 per cent quarter-over-quarter in the first quarter and GDP growth is forecast to come in at 1.8 per cent this year and next. This won’t shoot the lights out, but this figure is much better than it was.
There is also evidence that inflation is picking up in Europe, which should give Mario Draghi the air cover he needs to begin tapering, although he’s likely to do so in a carefully calibrated manner. In terms of timing, this probably won’t begin until later this year or early next year. In the interim, monetary policy remains loose and is unlikely to return to neutral for well over a year. However, as investors begin to focus on expectations of policy normalisation, we believe it’s likely that term premia — the excess yield investors require to hold long-term bonds — gets priced back into bunds and other core European bond markets. This would be positive for financials in particular and equity markets in general.
Global companies
To close, European corporate profit margins have yet to recover their pre-Great Financial Crisis levels. But this gives them scope for continued improvement, in contrast to US margins, which are currently at secular highs. Many world-class global companies domiciled in Europe are currently attractively valued on a relative basis; these stand to benefit from this uptick in growth. Of course, there are still important risks. Big issues such as Brexit, immigration and the parlous state of the Greek economy still need to be addressed. France is now moving on to its parliamentary elections, which will dictate the pace of Macron’s reform program and there’s a potentially contentious Italian election later this year or early next. But the momentum in Europe right now appears positive. In short, if Europe continues on its current trajectory, investors might have more reasons than usual to ignore the old saying, “Sell in May and go away.”
Erik Knutzen, Chief Investment Officer — Multi-Asset Class, Neuberger Berman
