Scepticism towards Europe remains high, with the eurozone ranking joint-bottom alongside Japan on fund manager positioning relative to 10-year history – putting it behind emerging markets, the US and the UK, according to the February BofA Global Fund Manager Survey. 
A separate recent poll by JP Morgan found that only 3 per cent of 700 respondents thought that continental Europe would be the top-performing regional market in 2021.
The sources of pessimism are well-known: a fragmented region with its own currency, but without a full federal toolkit; ‘growing pains’ and difficulty in decision- making due to the need for fairness; and the sheer number of disparate members. We, however, think there is a pretty good chance that Europe will surprise many, given the way events are unfolding both politically and economically.
Change is coming
At the political level, we are seeing the early stages of the formation of a new safe asset for the eurozone, the €750bn Recovery Fund, enabled via (previously taboo) borrowing at the EC level.
This will both increase confidence in the eurozone and create the conditions for increased long-term investment through the creation of a pan-European yield curve, unlocking significant investment from actors with very long time-horizons such as the pensions industry.
Amid persistent disappointment in the ability of policymakers to drive inflation towards the 2 per cent target, alongside the need to rebuild sustainably from the coronavirus pandemic, the licence and the means are now there for governments to adopt more fiscally-focused policy mixes, funded by generationally-low interest rates.
The recent accession of Mario Draghi as Italian prime minister and signs that Michel Barnier is considering running for president in the French 2022 elections are both supportive of this direction of travel, and, crucially, suggest that funds may be well spent.
In Germany, the 2021 election looks likely to result in a CDU/CSU coalition with the Green Party, which demands increased green investment and a shift away from the fiscally restrictive commitment to a balanced budget; mirroring the situation in the European parliament where no two parties now command a majority without the Greens.
We believe there are two key reasons why European equities might outperform. The first is that European core competence looks well placed to supply what the world increasingly wants.
Downtrodden financials and peripherals may rebound in a cyclical fashion driven by improved confidence. Europe’s key export-facing industrial leaders will benefit from an improving outlook for post-pandemic trade, helped by the more outward-looking Biden administration in the US.
However, from a structural point of view, the unleashing of potential firmly points towards Europe’s strengths. Europe doesn’t have a big consumer-facing tech sector, but it does have a lot of companies that use technology well – notably across smart green materials and industrials with large installed bases and high recurring revenues.
We would add the consumer-facing luxury goods and staples sectors, both of which punch well above their weight globally, when it comes to satisfying increasingly sustainable-minded consumers, policy makers and asset managers.
In short, many of Europe’s better export-facing companies and markets look well placed to supply what the world increasingly wants, at a time when both internal and external demand for these goods is on the rise.
Secondly, valuations and dividend yields look attractive on a relative basis.
Meanwhile in the both the US and Europe, regulation looks set to continue to tighten around US big tech, and the partial reversal of Trump-era tax cuts looks assured. Yet the US trades at a historic premium versus Europe, while it is Europe that offers premium levels of dividend income.
A good portion of Europe’s higher dividend yield comes from downtrodden financials, where the opportunity may be more cyclical than secular. Yet there are clear attractions across areas in which Europe excels. These include industrials, healthcare, materials (principally of the smart and green variety) and consumer discretionary, which includes luxury.
While the MSCI Europe Consumer Staples index offers a slightly lower yield than its US counterpart (2.5 per cent vs. 2.9 per cent), core components such as Nestlé, Unilever and Danone offer higher levels of income than key US comparators. In short, Europe looks like an attractive destination for income seekers looking for structural income growth opportunities.
Whatever the economic weather in 2021, we believe a focus on quality companies that generate persistent high cash returns supported by strong balance sheets will serve investors well for the long term. We also like to see identifiable barriers to entry, leading market positions, widening moats, aligned interests and long runways for growth.
Nick Edwards is manager of the Guinness European Equity Income fund. The views expressed above are his own and should not be taken as investment advice.