Since the surprise Brexit vote and Donald Trump’s US election win last year, political risk in developed markets has heightened, as anti-establishment sentiment has gathered pace.
Stock markets, which would historically disregard the comings and goings of politicians, now twitch nervously when an election approaches. Nowhere is this more the case at the moment than in Europe, where two, maybe three, major elections are taking place this year.
Read more: How currency movements affect stock markets
In France, the stock market fell on fears that anti-EU candidates were gaining popularity, only to rally when the polls proved impressively accurate for once and the more moderate candidate, Emmanuel Macron, won the first round. The stock market finally rose to a level not seen since 2008.
Indeed, European bourses generally have endured a tough cycle. Having outperformed global markets from the late eighties to the early noughties, they have underperformed for the past decade. Europe simply hasn’t seen the post-financial crisis recovery that the UK and US stock markets have enjoyed.
UK gets in on the act
Not to be outdone by her European counterparts, Theresa May decided to call a snap election for the UK next month, adding to the uncertainty in the very short term.
So when it comes to deciding whether to put money into UK or European equities, investors could be forgiven for thinking that they are between a rock and a hard place.
The UK’s larger companies have done very well since the EU referendum, buoyed by the fact that, while their costs are in sterling, many of their sales are in dollars or other currencies, so a falling pound has helped profit margins considerably. They now look slightly expensive though, with the FTSE 100 having experienced its best run of “new highs” in two decades.
Prior to the vote, the ability of many UK larger companies to continue to pay their dividends was also being questioned. The plunging pound bailed them out in this respect with better profits making the problem go away, but if and when the pound recovers, it could quickly resurface.
Don’t get distracted
European equities look a slightly better proposition. The elections are a distraction but once the politics are resolved, investors should hopefully be able to focus on the improvements in Europe: growing economies, falling unemployment, inflation throughout, improving corporate profits, and the fact that European equities are still cheap compared with the UK and US.
And at the end of the day, you are investing in stocks, not governments. Europe is still a huge continent, made up of many different countries, with a broad range of companies.
Europe also has a heritage of quality that has stood the test of time. The Germans make things very well and “Swiss made” is a label to envy. There are also successes that may surprise: two out of three of the largest manufacturers of robots are based on the continent, five out of six of the largest hearing aid manufacturers are there too, and even much-maligned Italy has a dynamic north and their companies are used to political change – they’ve had 45 leaders since 1945!
John Bennett, manager of Elite Rated Henderson European Selected Opportunities, is certainly upbeat. With inflation back and mergers and acquisitions on the rise, he believes double-digit returns are possible this year. His fund invests in 50 to 65 mega and large-cap stocks.
The smaller company universe is arguably even more exciting, with thousands of companies to choose from across the UK and Europe combined. For fund managers willing to put in the effort, some great hidden gems can be found and the growth prospects can be much better over the longer term.
A pan-European fund I like is T Rowe Price European Smaller Companies. Around 30 per cent is invested in UK smaller companies, with the rest based across Europe.
Mirabaud Equities Europe Ex UK Small & Mid is a bit of a mouthful, but also a good fund investing just in Europe, but in medium-sized companies as well as small.
The UK’s smallest companies now sit at their widest discount relative to larger companies in 17 years. It’s not necessarily that UK smaller companies are cheap but they are presenting a more attractive entry point for the long-term investor than we’ve seen in a while. Wood Street Micro Cap is a fund that invests in our very smallest companies and is worth consideration, as is Liontrust UK Smaller Companies fund.
However, one correct poll doesn’t mean the outcome of the next few weeks is a foregone conclusion, and investors shouldn’t get complacent. If Marine Le Pen wins in France on Sunday, Monday could see global markets plunge, along with the euro currency. But whatever the outcome it could, in hindsight, also be a really good buying opportunity.
Old Mutual’s chief executive Richard Buxton believes we are only half-way through the current economic cycle. If this is the case, then any certainty we can find in the coming few months may finally lead investors to have more faith in what has been the most unloved bull market in history.
Both UK and European smaller companies could reward brave investors.