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2022 was all about interest rates and inflation as European stock markets adjust to a new environment. It prompted a significant revaluation in markets, particularly in higher growth areas such as technology, while stock market success was confined to a handful of sectors – largely energy and mining.
With the environment so uncertain, investors were unwilling to look through macroeconomic considerations to the individual strengths of specific company. The question for investors is whether that will change. In the early weeks of 2023, markets still seem to be absorbed with the ebb and flow of interest rate expectations. When the US Federal Reserve and European Central Bank pushed back on expectations of a pause in rate rises, it knocked market sentiment. Many of the patterns seen in 2022 – a weakness in the technology and consumer spending.1
However, there is hope that the interest rate environment will settle down. Inflationary pressures are ebbing and there is greater clarity on the future direction of monetary policy. We see no immediate end to stock market volatility, but clarity on the terminal rate of this hiking cycle is moving closer. This would likely be enough to bring attention back to company fundamentals – the ultimate driver of long-term equity returns.
For now, European equities remain under-owned, and valuations are low. Stock markets look forward and some areas of the market, particularly within more-economically-sensitive sectors, have seen a significant adjustment to their valuations as investors have increasingly anticipated recession.
Just as they have anticipated the recession, they will start to anticipate and reflect a recovery some time before it becomes clear from the data. Timing the exact moment when the cycle turns will be difficult, and we believe investors need to be positioned for it ahead of time.
In the meantime, there are brighter signs from around the global economy. While lower energy costs and easing inflation may have grabbed the headlines, investors shouldn’t forget the potential impact of China. Its rapid retreat from its zero-Covid policy and the opening up of its economy could provide a significant boost for the global economy and for companies in Europe with China exposure. Recent economic data from the US has also surprised with its strength.2
We continue to see plenty of encouraging signs from the corporate sector. Corporate balance sheets are robust, and in much better positions than in previous downturns. Many companies in Europe have spent the last decade reducing debt, which gives them more flexibility and resilience compared to the Global Financial Crisis or other significant economic downturns. Corporate spending intentions also remain healthy.
There are also pockets of real strength within certain sectors. The EU Recovery Fund, Green Deal and the REPowerEU plan, as well as the recently announced Green Deal Industrials Plan (a response to the US Inflation Reduction Act) are likely to power demand in certain sectors for years to come - in areas such as infrastructure, automation, innovation in medicines, the shift to electric vehicles, digitisation or decarbonisation. These themes are well-represented in the BlackRock Greater Europe portfolio.
We also have exposure in the healthcare area, where we see significant innovation. Equally, and in spite of 2022’s supply chain related weakness, semiconductors continue to be a major growth market, with more and more smart devices requiring increasingly sophisticated microchips to function.
We are not calling an end to market volatility in the short-term. Nor would we suggest that the market is about to shake off its current obsession with the intricacies of interest rate movements. However, eventually the picture will become clearer and when it does, there are some good news stories that merit more attention from investors. This is where we are positioning the trust for the year ahead.
1 https://www2.deloitte.com/uk/en/pages/consumer-business/articles/consumer-tracker.html#:~:text=discretionary%20spending%20falling%20for%20the%20fifth%20consecutive%20quarter%20and%20essential%20spending%20remaining%20flat. - Deloitte Q4 2022
2 https://www.wsj.com/articles/economy-showing-strength-in-early-2023-after-last-quarters-gdp-gain-revised-modestly-lower-5b068ade#:~:text=The%20U.S.%20economy%20appears%20to%20be%20exhibiting%20strength%20early%20this%20year – WSJ 23 February 2023
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