Europe's really big (but maybe not so bad) year

November 19, 2018 Ian Taylor

          

Europe's really big (but maybe not so bad) year

Viewed from a distance, European markets may appear to be headed for a turbulent New Year, with big milestones lined up to shake investor sentiment. Among events we know will dominate headlines in 2019:

Merkel's last stand. Europe's longest-serving leader, Angela Merkel, will step down as leader of Germany's Christian Democratic Union party at the end of 2018. She hopes to stay on as chancellor until 2021, but her time at centre stage of the European Union (EU) has run out.

Brexit day. Deal or no deal, the UK is getting closer to a planned departure from the EU. The slated date is Friday, March 29, 2019 at 11 p.m. London time — the stroke of midnight in Brussels.

EU elections. The European Parliament wraps up its eighth term in April 2019, followed by elections May 23–26. Citizens of 27 member nations will elect 705 Members of European Parliment to form a new House.

Central bank shift. The president of the European Central Bank (ECB), Mario Draghi, will end an eight-year term in October 2019. Famous for a 2012 speech that vowed the ECB would do “whatever it takes to preserve the Euro," his words triggered a two-year rally in Eurozone stocks which soared nearly 50% over the period.

So, a pivotal year for the EU? Maybe not so much

When we look more closely and with context, as investors, Europe's ground-shaking year ahead may not mean all that much to its economic health or our outlook on the Eurozone.

Here's why:

A long, slow Brexit. Whatever comes of Brexit, a long transition period and talks on the UK's future relationship with the EU in areas such as trade will extend to at least 2020 and should taper any turmoil.

Solid economy. The Eurozone, collectively, is still one of world's largest economies. The national economies within it are on good footing and we believe the growth path is sustainable. Yes, economic growth is slowing following the region's best year since the financial crisis but, overall, the pace of expansion remains above potential.

Manageable risks. Time after time, the EU economy has held despite upsets to the fiscal cart: Greece. Ireland. Portugal. Greece (again). Today it's Italy, in a budget crisis. But there's “no chance of Italexit" Italy's PM insists. And there are limited signs of contagion to other Eurozone markets.

It's a process. The Eurozone monetary union is continually evolving, as countries adopt structural reform to increase productivity and reduce deficits. Spain started it. France is doing it. Italy is dragging its heels. The EU model wasn't intended to be an end in itself, but a movement for progressive economic integration.

The Europe we love: good companies that transcend geography

We believe that top-down, global, macro analysis and and understanding regional risks can complement traditional, bottom-up portfolios, where we can keep our focus on company fundamentals.

You'll see many European holdings in our MD portfolios are global businesses planning for the future and poised to weather short-term disruptions—in 2019 and beyond.

Here are a few worth noting:

  • In Spain, we hold a position in fashion giant Inditex—you may know it better by its key brand Zara—the world's largest apparel retailer. Its leader, Pablo Isla, was just named the world's best-performing CEO for the second year by Harvard Business Review.
  • Also in Spain, Amadeus IT has been a strong performer in MD's international portfolios, despite headwinds due to a weaker Euro. It is the leader in IT solutions for the global travel industry—it counts Air Canada and WestJet as customers.
  • While Italy is currently at economic odds in the EU, we don't own any Italian banks in that vulnerable sector. But we do own a very successful utility company called Enel, a trend-setter in alternative energy, we wrote about last week.
  • In France, several global companies in MD portfolios stand out as leaders in their areas. We like L'Oréal as its cosmetics and personal products business is resilient to global economic cycles. It also has no net debt on its balance sheet, keeping it less exposed to the whims of financial markets.
  • If you wear glasses or contacts , there's a good chance they originate from EssilorLuxottica, created by the merger (closing as we speak) of Essilor of France and Luxottica of Italy. Its brands include Ray-Ban, and LensCrafters.
  • Air Liquide is a leading supplier of chemicals and industrial gases, including those used for medical purposes. We recently learned of their ambitions to develop their hydrogen business for fuel cells.

We manage the things we cannot change — like currency risk

Since much depends on the value of the Euro, we actively manage our currency exposure to offset that. Although the euro remains undervalued from a longer-term perspective, short term indicators from our currency models including inflation adjusted interest rates are very weak and we therefore take a modest short position in the Euro, in particular relative to North American currencies.

We can always guess future headlines, but won't ever try to out-predict what markets may do in Europe—or anywhere.

More important is to stick to our strategy, and find opportunities that bring value to your portfolio over the long term.

For more information about European headlines or your portfolio, please contact your MD Advisor.

About the Author

Mark Fairbairn, Assistant Vice President,Investment Management and Strategy team

Mark Fairbairn, CFA, B.Eng., is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He is responsible for the non-North American equity funds and pools as well as the currency overlay program within the equity funds.

More Content by Mark Fairbairn

About the Author

Ian Taylor

Ian Taylor, CFA, CIM, is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He oversees strategic and tactical asset allocation mandates, alternative investment mutual funds and is a member of MD’s Tactical and Risk Allocation Committee.

More Content by Ian Taylor
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