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Europe’s struggle to break free

At the start of 2018, it looked likely that interest rates could start to rise across Europe, signaling the end of the necessary post-crisis readjustment in the financial sector. However, as is often the case, the themes that drive markets at the start of the year can often be forgotten by the end.

As 2018 has progressed, companies in the financial sector, in particular, have struggled to absorb or pass on to customers increased costs, while the continuation of low interest rates has squeezed profit margins. Europe has been unable to wean itself off the dependence on exceptionally-easy monetary policy.

Additionally, there is also political uncertainty and with that, policy uncertainty. Spain has a minority government. Germany is wrestling with immigration concerns. The UK is dealing with the complexities of Brexit, and Italy has experienced a rise in populism. All these developments reflect a discontent with the status quo, but there are few clear proposals for a working alternative.

This backdrop has constrained the progress of the broader market with only a few stocks and sectors advancing. Of the latter, oil, defense, luxury goods and technology have been the notable outperformers. The reasons for this are fairly clear. The oil sector has benefited from the recovery in the oil price, continued supply disruptions and some dividend support.

Defense stocks, meanwhile, are fairly small in number and enjoy strong order books while luxury goods companies have resolved supply chain problems, made some progress in addressing online sales and recovered from the decline in consumption from China. Finally, technology has been the stand out sector so far, as the market has embraced growth and shunned pretty much everything else.

Although, Europe does not enjoy a large technology sector (there are no Googles, Apples or Amazons) there are some niche areas that are growing fast and where Europe leads the way.

For example: payment systems, banking software, travel logistics and critical aspects of semiconductors.

On a more modest level, online disruptors in distribution and sales are also doing well as they exploit first-mover advantage and build scale. The potential for such companies to be acquired by larger players has been supportive of their share price.

With growth at a premium, companies that exhibit sustained growth in a specific area have been popular with investors, with little regard paid to valuations.

Despite the popularity of the technology sector, we still think some caution is warranted with new legislation on data protection, cybersecurity and regulators taking a keen interest in tax payments and dominant market positions. Valuation as well as momentum needs to be considered. The market is currently ignoring valuation both for those growing and those struggling to find growth.

Looking ahead, the future of many European companies is bright, but more sectors and stocks need to advance if the broader European market is to break out of its current narrow trading range and continue to make progress towards economic normality.

Important Information

Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

Companies mentioned for illustrative purposes only and should not be taken as a recommendation to buy or sell any security. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.

ID: US-200918-73001-1