Investors can be reasonably optimistic on the outlook for European equities particularly when compared to other equity markets and asset classes, James Rutland fund manager European equities at Schroders said.
Mr Rutland added: “The reason for that is that positioning in Europe is really negative. If you look at active flows, US domiciled investors are typically underweight Europe. If you look at passive flows, ETF flows have been quite negative into Europe so we can be optimistic.”
But, he said there was a caveat. The European stock market might be close to all time highs, that this is hiding a significant dispersion below the surface.
Mr Rutland added: “If you look, there has been a certain type of company that has done well in this bull market. And that type of company has benefited from falling interest rates and falling yields.
“An example would be consumer staples. They look quite expensive and then the value style looks quite cheap at the moment. When I'm thinking about value I'm thinking about banks, chemicals and capital goods.
“At that level we can be a lot more positive and I’d be a bit more cautious on the growth styles, and the more defensive styles in that market.”
As a result, Mr Rutland does not believe now is the right time to build up a portfolio with defensive shares.
He added: “At times when the economic data is good and the market is bullish, typically we try to buy defensive shares and when the mood is bearish and economic data bad and everyone is thinking recession we will be thinking more cyclical shares.
“If we go back to the start of 2018, a lot of people were talking about synchronised global growth. Everyone was very bullish and the market was excited. That preceded a sell-off of about 20 per cent in European equities and today we think we are at the opposite point.
“We are looking to take advantage of the negative sentiment in the market to build a more cyclical portfolio. The types of companies we are looking at are autos, chemicals and companies exposed to the industrial cycle, rather than those defensive shares which look quite expensive at the moment.”
Mr Rutland explained that when building a defensive portfolio the key is capital preservation particularly at the end of a cycle, so that typically means a portfolio full of defensive equities and not cyclical stocks, which are typically affected by macroeconomic and systematic changes in the overall economy.
He added: “Typically at the end of the cycle, we see a rush or exuberance, cyclical shares get expensive and then defensive shares look very cheap.
“As we go into the downturn defensive shares offer you earning stability. Defensive sectors like consumer staples, health care; people continue to buy those products.
“But also they are cheaper so you have valuation protection as well. We don’t think that we are in that environment at the moment. We are looking to be more cyclically exposed as we look for that trough in the data.”
