The consensus view is that Europe is now a buy following the announcement that the European Central Bank (ECB) has started quantitative easing (QE). But I suggest that there were already signs that economies were picking up and that, with equity markets looking cheap, sentiment trailed fundamentals. QE is the icing on the cake and will certainly help sentiment to catch up. I have therefore added to the Growth portfolio's exposure - but focusing on dividend payers when doing so via JPMorgan European Investment Trust Income (JETI).
JPMorgan European IT Income (JETI)
European markets have, until very recently, performed poorly relative to other indices over recent decades. International investors have tended to view many EU economies and markets negatively. Even domestic investors tend to favour bonds over equities, and then domestic companies if they venture there at all. The self-inflicted eurozone crisis has not helped sentiment.
Yet the economic indicators are slowly turning more positive - albeit from a low base. Unexpectedly strong data is feeding through to GDP forecasts being upgraded. Last month, the manufacturing and services sectors' activity hit a four year high, whilst consumer confidence is rising.
Furthermore, two key money supply measures are growing much faster. This bodes well regarding concerns about deflation. It also suggests the credit squeeze is easing. As banks' balance sheets gradually improve, they are lending more. Meanwhile, eurozone retail sales are growing at their fastest rate in more than a decade, unemployment is now starting to fall, and real wages are on the rise.
Much of this positive data has taken markets by surprise. A good Q4 reporting season, ahead of expectations, has encouraged earnings upgrades for the third consecutive quarter. The figure for Europe is around 5 per cent this year, compared to 4 per cent for the US. We should also remember that, having been through a storm, earnings growth is at an early stage of the cycle and will be helped by a weakening euro assisting exports.
But after their recent strong run, are markets up with events? By way of comparison, the US market is around 27 times its CAPE (cyclically adjusted price/earnings ratio) whereas Germany is on 16 times. European CAPE valuations are around their average over the last three decades.
Meanwhile, the eurozone's 2015 equity yield is forecast to be 3.5-3.6 per cent, which is nearly double that of the US. On a price-to-book basis, reflecting the extent to which a share price exceeds the company's asset value, Europe trades at around 1.5 times compared to 2.5 times in the US. So I suggest share prices still do not reflect prospects. There is still plenty of room for multiple expansion and therefore a long way to go in this rally.
The direction of travel has been reinforced by the ECB's recent decision to print money and buy bonds. QE will help both confidence and avoid a deflationary slump. It should also help to reduce the impact of a Greek exit from the euro if it ever happens.
Furthermore, a similar pattern to the US and UK could see QE in operation for at least a couple of years, whatever the ECB says - never underestimate the political will to preserve the euro. And all the evidence from elsewhere suggests QE is good news for shares.
Of course, risks remain. Perhaps the biggest could be the longer term failure of eurozone members to make the necessary structural reforms to ensure competitiveness. QE may buy time, but governments must produce the policies. Meanwhile, the debt mountain still grows. In addition, for monetary union to work, fiscal union and greater harmonization generally is required. If this does not happen, the markets will not have finished with the eurozone crisis - the issue of democratic consent should also not be ignored.
However, for the moment, improving economic figures, QE and reasonable market valuations will reward equity investors. Enter JETI. Its objective is to provide a growing income and long term capital growth from a portfolio of mainly larger cap stocks in continental markets. It has comfortably beaten its benchmark over one, three and five years, yields 3.4 per cent with reasonable revenue reserves, and stands on a 5 per cent discount.
As for sector and stock strategy, the portfolio's biggest deviation from benchmark is being overweight financials - supported by credit easing - and underweight healthcare. But stock selection is focussed on company fundamentals including dividend prospects, rather than sector strategy. Overall, JETI is a quality holding to tuck away for the longer term.
Other portfolio changes
Other changes in the Growth portfolio during March were the sale of Baillie Gifford Japan Trust (BGFD) after a phenomenal run and when standing on a small premium, and the top-slicing of both Oryx International Growth Fund (OIG) and Fidelity China Special Situations (FCSS) again after strong runs and good profits - I never mind leaving a little something on the table for the next investor.
I also further top-sliced International Biotechnology Trust (IBT) for reasons given in a recent column ('Recycling profits', 6 February 2015). With some of the proceeds, I have introduced Acorn Income Fund (AIF) for reasons I will cover in my next monthly column.
As for the Income portfolio during March, I top-sliced IBT and introduced AIF.
