La lettre
Performance of European companies overshadowed by political problems
- As a general rule, elections tend to generate uncertainty and, as a result, can exacerbate financial market jitters.
- While some European countries already dipped back into recession in the first quarter, a reading of euro zone corporate results offers a much more optimistic view.
- For equity investors seeking exposure to more dynamic economic regions, these internationally oriented European companies are the best investment option.
- At the end of the day, after the beating taken by European stocks last summer (especially cyclicals), the market is gradually pricing in the strong resilience and quality fundamentals of industrial groups, which offer the best protection in Europe's persistently challenging economic environment.
We are still far from the cycle peak
- Observing the past helps understand world developments and new beginnings.
- During the technological economic cycle of the late 1990s, the use of "new technologies" deployed by companies had little impact on their operating structure. It took years for this highly investor friendly period to end in a bubble.
- The industrial cycle (coal, steel, cement, machine tools), which paved the way for economic recovery and the rapid growth of emerging countries, sparked a stock market rally that lasted until the market lost its head and created a new bubble.
- The 2008 crisis stopped this momentum dead in its tracks. Since then, however, many companies have held steady. Their structure has changed and the barriers to entry on their markets are higher due to the concentration of players and technology. The most resilient companies have taken advantage of the advances made in the past decade, drawing on a cycle of innovation and concentration.
- The rapid rebound had some investors believing that the cycle peak had already been reached. Since 2009, however, growth in corporate revenue and margins has primarily been driven by geographic expansion or new businesses. In many sectors, historic activities are just starting to get back on their feet. We are only in a recovery phase.
- Investing in industrial names right now is not about betting on economic growth, but rather on the impact of companies' structural changes on their business and margin levels, which has yet to be priced in by the market. As always, it takes the market several years to catch on. And value investors can take advantage of this long development.
Our investment axes in a crisis environment
- With the exception of the US market, most of the world’s stock exchanges performed very poorly in 2011.
- Taking a step back, however, we can see that the situation is not really that dramatic. First of all, looking at European government finances, the prospect raised last summer of seeing the Euro zone collapse has been ruled out. Furthermore, the same observation can be made based on the results of the latest earnings releases by European companies, showing that the impact of the crisis appears to be very limited.
- Nonetheless, the Euro zone problems have yet to be resolved. The challenging macroeconomic environment calls for appropriate stock picking, which does not necessarily mean we want to focus on stocks traditionally considered as defensive.
- Like 2003 and 2009, the market slump has given us an opportunity to build up positions in industrial companies boasting a robust balance sheet, as well as highly diversified geographic exposure and solid market share. These companies will prove to be the most defensive in a depressed economic environment.
- The year-to-date equity market rally is just the first step in the correction of the excess trends sparked by the waves of panic that overwhelmed the markets in 2011. The markets can be expected to continue playing catch-up, backed by solid company performances. Despite their weak domestic market, European industrial companies are well-positioned to take advantage of the momentum in emerging markets and the US recovery currently taking shape. The persistently substantial discounts out there are ideal for value investing, as they were in 2003 and 2009.