Quality Growth Boutique

3Q 2020 European Equity Outlook: Opportunities and risks as Europe re-opens for business

Outlook

Donny Kranson considers the effects of stimulus, Brexit negotiations and the potential for another market downturn.


Global equity markets rallied in the second quarter almost as quickly as they declined amid the shock of the pandemic. Share prices have responded to massive global monetary and fiscal stimulus and seem to be ignoring the risk of a second COVID-19 wave.

European equities have recovered well ahead of the economic data. While some damage has been done to the economy, Europe has done a relatively good job of protecting businesses and jobs through temporary measures such as paying worker salaries. The next few weeks will show how quickly businesses bounce back as the economy is re-opened.

The combined forces of the US Federal Reserve with European and international central banks brings a lot of firepower to paper over fundamental cracks in the economy. However, this is a legitimate crisis and countries need to use the tools available to them. This is not the time to worry about the downside of actions taken. Further, governments and central banks have more capacity to act if required.

Countries in Europe are starting to open up, which is important for the peak summer travel season. However, both businesses and consumers have been hit and have less to spend. Many will also be nervous about the virus. Normalization will happen, but it will take time.

Crises can also lead to structural change. One positive step being seriously discussed is a European recovery fund that could lead to a more integrated and stable Europe over time.

Brexit remains unresolved, and many hard parts of the negotiations remain. The EU wants to ensure a level playing field to prevent the UK from undercutting EU companies by lowering tax rates, reducing standards for workers' rights, undermining environmental protections, or increasing state aid to companies. The two sides also need to work out customs checks for goods crossing the Irish Sea.

Some consumer staples companies have not held up as well in this downturn as in the past because of where the products are consumed. Demand for alcohol in certain markets has shifted to home consumption, but the move has not been enough to offset the overall decline. Similarly, out-of-home consumption of food and refreshments, such as ice cream, has declined. As economies re-open, we expect those businesses to rebound.

Earnings estimates have been beaten down for 2020, while 2021 earnings should still be below 2019 levels. The market rebound might indicate that either investors are looking through to 2022, or more likely are responding to short-term news around COVID-19 and stimulus measures. In the case of a severe second wave, the market recovery could prove fleeting. In that case, high quality stocks that have secular growth behind them should do well. And active managers can use volatility as an opportunity to take advantage of the swings in the market.

 

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