Portfolio Manager Donny Kranson discusses monetary policy, inflation, the consumer staples and luxury segments, and upcoming elections.
European equities have performed well in 2021 but remain at a wide discount to US peers. Against a relatively favorable backdrop, there are reasons for investors to be positive about the outlook for Europe. Interest rates remain below zero, the economic backdrop is decent, COVID is coming under control and earnings estimates look strong. In addition, the EU has passed the NextGenerationEU recovery fund and countries have eased their approaches to fiscal austerity.
Forthcoming elections could lead to volatility. However, even with a new leader in Germany for the first time in 16 years, there is unlikely to be major negative change. French elections next year are also unlikely to present an extreme outcome. Northern European politics appears more benign on issues like fiscal austerity and immigration.
We believe European monetary policy should stay loose. Europe has suffered from a long period of weak inflation and policymakers may allow it to run hot for a time. In periods of higher inflation, investors need companies with pricing power that can help deal with rising input costs. We feel luxury goods companies and consumer staples are a good fit. If luxury goods are a little more expensive, their customers can still afford them, while staples represent essential everyday products.
Europe is dealing with rising energy prices as it switches from fossil fuels to more renewables and green energy capacity and, at least in the UK, a lack of truck drivers to deliver fuel. Higher energy prices will push up inflation but will be deflationary for core inflation as consumers will have less money for other goods.
Input costs for consumer staples have increased faster than expected both in terms of raw materials and shipping. It is easier to put through price rises on consumer staples in an environment where all prices are rising. Moreover, the pricing gap between brands and private labels is shrinking. We believe consumer staples earnings and stock prices should continue to be resilient in an economic downturn.
China represents a large market for European luxury goods. The government’s push to common prosperity in China could impact luxury goods consumption, depending on how measures are implemented. However, demand will not disappear, and there is also potential for more consumption in the US, which under-indexes on luxury items.
Companies in Europe are leading the way on ESG. Being early adopters can bring benefits for brand equity with consumers, corporate goodwill with regulators, lowered cost of debt, and help with recruiting employees. Companies that delay will see the cost of inaction. For investors, we feel planned investment in ESG today is better than an unplanned investment tomorrow.
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