The stars have been aligned for European equities for much of 2017. The markets progress and company earnings have for the first time in many years been free of external shocks, recessions, sanctions, credit or currency crisis, surprise policy shocks. James Rutherford, European Equities Portfolio Manager at Hermes Investment Management, discusses how this makes 2017 suddenly an unusual year as growth forecasts have held up, unlike in many recent years where estimates have dwindled over the course of the year.
Despite the positive start, some caution remains as Euro strength (notably against the US dollar) will provide a headwind to reported numbers over coming quarters. An element of this has been discounted; overseas earners have underperformed domestic-focused stocks. This is a translation issue rather than a transactional issue so the core organic fundamentals remain firm. The Euro strength may see Draghi soften his tapering stance or maybe the Fed becoming more hawkish. One must remember these sizeable currency moves have moved with rhetoric and political perception, not absolute policy actions, so reversals are easy to see. A more dovish tone would suppress yields in Europe and support a more growth-oriented stance.
The recent market has been characterised by narrowing breadth with the strength of the Euro pushing investors to more domestic plays, particularly financials and utilities. These are not growth areas and would appear to be more default type positioning. Stock reactions to results would suggest much of the good news was discounted, with companies who beat or exceeded expectations being unrewarded with positive share performance and misses being severely punished even for short term issues. This highlights the momentum driven nature of the market where short-term issues are sold off and the money moves elsewhere. Indiscriminate by nature, but this creates opportunities for those willing and patient to see beyond that particularly moment. We have taken advantage of some situations where stocks have been unfairly punished, and have removed stocks where fundamental headwinds would appear more permanent. We can see that earnings growth for next year, whilst still positive, will temper somewhat as hedging policies roll off and reveal the negative impact of the strong Euro. Our focus has been on stocks where we see an acceleration in growth rates going forward into 2018. Qiagen has been initiated as a new position, and we have added to positions in Novo Nordisk, Worldpay, Convatec.
Until recently, Qiagen – a manufacturer of medical devices and tests – has seen growth held back by intense competition to its HPV test, one of its most important business areas. This is now coming to an end, allowing the company to accelerate growth driven by two exciting new products. With the launch of their Next Generation Sequencing instrument, which is used by doctors and researchers to analyse diseases to a level of detail not previously possible, Qiagen is exposed to a market that could be worth tens of billions of dollars. Meanwhile, the QuantiFERON Tuberculosis test, the next generation test for the disease which has significant benefits over the traditional test, still only has a 15% share in this market and can continue to take share from the 100 year old skin tests.
Novo Nordisk is focused on the growing diabetes market, but had seen sentiment turn against it due to concerns over pricing in one of the larger segments of the market. However, we believe the long-term fundamental story – exposure to a structurally growing market and a strong product pipeline – remain intact. We are particularly positive on the prospects for a number of the company’s new and upcoming drugs such as Saxenda for weight loss which is a new market that Novo Nordisk is building from the ground up and Semaglutide, a drug that looks to have far better efficacy than incumbent products in the GLP-1 market.
ConvaTec is a leading player in the global wound care and ostomy markets. Recently we have been able to increase our position in the stock because of short-term issues which have concerned investors, such as temporary manufacturing problems and higher costs associated with launching innovative new products. However, these have no bearing on the long-term investment thesis – exposure to attractive end markets and the opportunity to increase margins to in-line with peers. Indeed, the main investor concerns during the IPO process; the company’s ability to turnaround performance in the key Ostomy division and achieve its Margin Improvement Programme targets, appear to be exceeding expectations.
In a world where debt continues to accumulate, growth will continue to be relatively benign and characterised by short and shallow cycles. Markets and stocks will remain highly sensitive to policy and currency moves and our focus will remain on the structural plays, where earnings and cashflows are driven by factors independent of the economic environment but also recognising that stocks don't operate in a vacuum, remembering our old adage that markets are not economies.