In the wake of the volatility created by the US President, investors are seeing the opportunities in Europe. Ben Leyland & Rob Lancastle, managers of the JOHCM Global Opportunities Fund look at how durable portfolios might be built when investing in the region.
The US proposal to impose a wide swathe of tariffs on global trading partners set off a sharp round of volatility in financial markets. Confronted with such a strong reaction, the administration quickly backed off. But clearly the prospect of a radically different approach to trade was credible. Globalisation is unlikely to go away, but neither is it likely to stay the same.
Perhaps just as important, and typical of these kinds of episodes, is that there were other signs of fundamental change. Inflation is well below its 2022 peak but still above where most central banks would like it to be, with the prospect of tariffs adding to the potential for higher levels to persist. Given soft, or at best mixed, employment data, investors are having to fret over the probability of stagflation.
This comes at a time when investors are losing the last of their lifelines. The much fabled ‘magnificent seven’ was progressively whittled down to four and then finally came apart when ‘DeepSeek Day’ put in doubt the massive investment that AI models had predicated until then.
Where to turn?
Just as US markets were going into reverse, European markets were waking up. In the first four months of the year, the S&P 500 was down 4.32%, the Russell 2000 down 11.04%. The Euro Stoxx, by comparison, was up 7.42%. The German index, the DAX, was up 13%1.
The switch was driven at a broad level by the realisation that a cluster of issues, including the war in Ukraine and the reset in US diplomatic relations, were forcing a change of direction in Europe. More specifically, investors were impressed by the announcement by the then-elect chancellor, Friedrich Merz, that Germany was willing to loosen its tight fiscal stance, the last of the G7 to do so. Were Germany to run its public debt to 100% of GDP, equivalent to other ‘low debt’ G7 states, it would represent around €1.7 trillion ($1.9 trillion) in additional spend.
Some of that money will seep into the global economy. Quite a lot will spread through the European Union. But the main beneficiary will be German enterprise. For international investors, this is an opportunity to avoid recession by investing in Europe and Germany’s non-cyclical sectors, while avoiding the full impact of tariffs by focusing on sectors with a strong domestic bias.
What are the opportunities?
From a country perspective, it makes sense to us that by far our most significant overweight is Germany, currently around 20% of the strategy. Sweden and France are also overweight, being economically close to Germany. At a sector level, our preference is for utilities, materials, industrials and energy, sectors where we can find companies that meet our criteria of ‘quality value’, which is strong balance sheets, an established franchise and a compelling valuation.
Among our most prominent overweight positions is a financial running one of Europe’s leading stock exchanges, along with an internationally significant clearing house. These are core businesses that benefit from market volatility as it stimulates trading. But more importantly, over the long term, they are extremely difficult to replicate, given their need for complex and substantial technology, and the near-monopolistic advantage of their historic brand recognition. Their day-to-day activity spins out a mass of data whose value increases the longer it accumulates. As a service provider, it is domestically focused but tends in any event to be free of tariffs.
Another sector that we like is defence, an interest that we have pursued for many years, first in the US and from around five years ago in Europe. Companies in the sector typically have high barriers to entry and relatively stable long-term earnings, both characteristics that we like. In Europe, where our interest is now focused, we originally invested in a company whose value was less in hardware and more in technology used across multiple systems, a model we thought provided better product diversity. Since then, we have built up a ‘cluster’ of holdings, a stance that has had a powerful payoff in recent months as a radical increase in defence spending is now front and centre of the European political discourse.
Tariffs, artificial intelligence, geopolitical re-alignment – these are important developments that will persist and re-shape the macro environment. But the most lasting change remains the return to a world with a positive cost of capital. In our mind, this brings back into focus the characteristics core to our approach, good quality companies with a strong, long-term franchise, available at a valuation that has clear and substantial upward potential.
[1] Bloomberg, all in local currency.
Main image: nejc-soklic-yZ6MnFo5hX0-unsplash
