By Michelle McGagh of Citywire
European equities aren’t as good a deal as investors believe, according to Peter Fitzgerald of Aviva Investors, who is looking to the US for growth following the election of Donald Trump.
Fitzgerald, global head of multi-asset at Aviva Investors, believes investors are failing to take into account the composition of indices when comparing US and European stocks. ‘There is the common belief that European equities are cheap but what is not taken into account is the composition of the index,’ he said.
‘You need to adjust the composition and factor in the S&P has 20% in technology [companies], which trade on higher multiples but Europe only has 2% in technology but more in financials and commodities. When you compare the adjusted market composition then you see [European equities] no longer look as cheap.’
European valuations have been pushed down by financials in particular, but despite European banks being inexpensive, Fitzgerald said he would rather back US banks which he regarded as more stable.
Fitzgerald (pictured) also bought into US smaller companies by adding to investments in the Russell 2000 index after Donald Trump’s shock presidential victory.
‘We are overweight US equities and we added to our position after the election of Trump and on the day of the election we sold European equities and bought the Russell 2000,’ he said.
‘The Russell 2000 is the largest long equity position we have today. And we are neutral European equities.’
Noise over Italy
The ‘significant political uncertainty in European equities’ also played a part in Fitzgerald’s reluctance to back the sector. Italy has become the latest concern as voters rejected an amendment to the Italian constitution to improve the way the Italian parliament works.
Although voters were quick to use the referendum to express their disdain with the political elites, as in the case of Brexit, Fitzgerald said it was ‘not a significant market event despite the noise’.
However, he was more concerned about the potential for Marine Le Pen, leader of the Front Nationale, coming to power in the French elections. Despite opinion polls showing Le Pen has 35% of the vote, Aviva Investors is not ruling out a win by the far-right candidate.
Florian Ielpo, head of macro research at Cross Asset Solutions, said investors should keep an eye on next year’s European elections.
‘The political game changer is likely to come next year, with elections in the Netherlands in March, France in April and Germany in August 2017,’ he said.
‘From an investment perspective, we will be watching the level of popular support for the Front National/ Front de Gauche in France and the Alternative fur Deutschland/ Die Linke in Germany very carefully, and investors should expect further widening of sovereign spreads against German debt should anti-EU political forces continue to gain favour with voters.’
With such political instability in Europe, the election of Trump in the US is not looking quite as problematic. Plans to grow the US economy by 4% a year will push it further ahead of Europe in the short term.
Stuart Robertson, Aviva Investors senior economist, said it was unclear just what Trump’s stimulus package would look like but it would be a positive for the US economy.
‘There will be some form of fiscal package comprising infrastructure and tax cuts,’ he said. ‘US inflation is a rising trend already and the economy is running reasonably warm and we could get some economic growth and that will lead to inflation pressure but it has got to be a plus for the US economy in the short term.’
While Robertson said Trump must ‘be given the chance to govern’, he admitted that it would not all be plain sailing. He pointed to the potential trade war with China, which Trump has said should formally be labelled a currency manipulator.
‘More important is the tariffs he could impose on [imports from] Mexico and China,’ said Robertson. ‘We have to be aware but we don’t know what’s going to happen.’
Jan Dehn, head of research at Ashmore, the emerging markets specialist, said the Sino-American relationship was key for investors.
‘Global markets have been busy pricing in something approaching perfection in the US outlook since Donald Trump’s election…The reality is likely to look rather different: fiscal stimulus and financial deregulation will create more inflation than growth and widen the trade deficit, while protectionism will lower the US trend growth rate,’ said Dehn.
Dehn said that ‘two broad developments will emerge to dominate the relationship between the US and China over the next four years’.
‘The first is that China’s influence as a global economic and political power will increase as America shrinks from the international stage. The second development will be the renminbi’s growing challenge to the dollar’s current status as the pre-eminent global reserve currency as inflation returns to the US,’ he said
For Fitzgerald, the biggest threat comes in the shape of the bond market. ‘The biggest risk for the US is the bond market selling off more aggressively than people expect,’ he said in response to higher inflation.
‘If you look at the yield curve in the US it is still flat…if you have an increase in risk in the US that will step up because people will demand a premium for longer-traded bonds, especially in the US where they do not have a structured buyer of long-term debt [like the UK does] in the form of defined benefit pensions – those yields could rise more sharply than we are expecting.’
In terms of broader risks, Fitzgerald said ‘problems with Europe will not go away’ and there was also the precarious situation of ‘three major powers with nuclear weapons who do not have the open channels [of communication] they had before’.