European Equities Update:

Investors take tentative steps back into the market

European equity markets have performed well recently driven by signs of economic stabilisation. Among the main sectors to participate in the recent rally were those most heavily oversold during the economic downturn including banks, automakers, industrials and basic materials.

However, within these sectors, balance sheets predominantly remain under repair meaning there is little likelihood of a return to sustainable profitability or dividend growth in the short term. In addition, although there has been a moderation in the rate of economic decline, European monetary authorities have still felt compelled to cut rates to a record low alongside talk of implementing a quantitative easing programme. This suggests there could be more pain to come.

Income offers opportunities

In light of the uncertain outlook, equity income funds offer an interesting way to participate in the potential market upside while offering a solid income stream. Within our own recently launched European Equity Income Fund, we have struck a balance between the more cyclical areas, while also seeking to take a slightly longer term view by investing in stocks where earnings and dividend payments are likely to be more resilient.

One of our preferred plays is the telecoms sector, which trades at a large discount to the market with an average yield of 7% against a market yield of 4.5%. We have confidence in the dividend paying ability of this sector which continues to generate strong cashflows. We have also built up holdings within the healthcare sector, which has been able to generate earnings growth as well as increase dividends. Among our favoured healthcare names are Novartis and Sanofi-Aventis, which are yielding at a premium to the market.

Elsewhere, we have a significant holding in the oil and gas sector where established names such as ENI and Total are benefiting from the prospect of an economic recovery. We also hold smaller companies with potential to grow their dividends over time, such as Galp Energia of Portugal, which has good exposure to the burgeoning Brazilian oil and gas story.

Uncertainty likely to remain

Looking ahead, while European equity markets may remain volatile in the short term, there are signs that the worst could be over. However, until confirmation is received in the form of a sustained recovery in earnings, the best option for many may be to focus on value and income where it is available.

Standard Life Investments

Checked by James Pearcy-Caldwell
Director

Notes …

* This newsletter has been prepared with all possible care to ensure its accuracy. It is based on our current understanding of legislation and HMRC practice. 
* Neither Aisa Direct Ltd nor any of its employees can accept responsibility for any errors or omissions. You should seek further professional advice prior to action.