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European stock markets – at the heart of the coronavirus crisis

Investment Analyst, Kate Marshall, looks at how Europe's economy is being impacted and considers how three active European funds on the Wealth 50 are performing.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

China's economy was the first to be shut down by the spread of the coronavirus. But as the virus spreads around the world, countries are taking drastic measures to try to contain it.

Businesses, shops, transport, and leisure and entertainment venues have been closed. Mass populations are now confined to their homes. Economic activity has been heavily disrupted, and now governments worldwide are intervening with extraordinary policies aimed at sustaining both livelihoods and businesses.

The economic fallout could have repercussions for years to come, but here we take a look at what's happening in Europe right now.

This article isn’t personal advice. If you’re not sure if an investment is right for you please ask for advice. Past performance isn’t a guide to what will happen in the future and all investments can fall as well as rise in value, so you could get back less than you invest.

Can Europe cope?

Europe is now the epicentre of the coronavirus pandemic, also known as Covid-19. At the time of writing, the largest number of confirmed cases are in Italy and death tolls are growing more quickly in Italy and Spain than they did at the same stage of the outbreak in China.

With so many people and businesses out of action, there’s still significant uncertainty around Covid-19 and its potential impact globally. We shouldn’t rule out the possibility things could get worse before they get better.

Europe has dealt with numerous crises before – most recently the 2008 financial crisis and the European debt crisis that peaked in 2012. Many businesses survived and some eventually emerged in a stronger position than they were before. Stock markets also went on to reach new highs.

But the issue this time is that the crisis is linked to people's health, rather than stemming directly from the financial system. This has created fear and panic, which inevitably has an impact on the way we go about our daily lives, and the action investors take. It means the recent stock market falls have been indiscriminate – investors have been selling shares of companies across all sectors, paying little attention to longer-term fundamentals.

It also means the impact on economies and businesses could be significant, at least in the short term. Businesses across Europe have already shut down, or have had to come up with other ways of working.

What's the economic impact so far?

The latest numbers suggest business activity in Europe has fallen to record lows, with steep declines in manufacturing and services.

The Purchase Managers' Index (PMI), which tracks the direction of economic trends and indicates whether markets are expanding or contracting, recently dropped to its lowest ever level. The euro zone PMI fell from 51.6 in February to 31.4 in March – a reading below 50 represents an economic contraction compared with the previous month.

The data for this latest reading was taken before some of more severe actions around lockdowns came into effect, so April’s output could potentially be worse.

The most severe downturns in activity have been seen in consumer-facing areas, such as hotels, restaurants and leisure. The transport and travel sectors have also been heavily impacted.

The full impact will vary from country to country though. Italy, Spain, France and Germany are some of the countries likely to come under the most pressure, based on the severity of the outbreaks so far. Some northern European countries, like Sweden and Denmark, have seen fewer cases. But we all know how quickly things can change, so their level of immunity will depend on the actions they're willing to take to contain the outbreak.

Can the ECB stop another euro zone crisis?

So far the European Central Bank (ECB) hasn't been shy with its plans to help Europe's financial system. It recently announced it would buy an extra €750bn of bonds over the next nine months, including both sovereign and corporate debt.

The ECB also said there are no limits to its commitment to the euro, suggesting it’s more than prepared to take further action if required. This is quite a statement, especially as the ECB has previously placed a cap on some its measures, like the percentage of each country's bonds it's willing to buy.

This most recent announcement had an immediate impact on bond markets, with Italian, Spanish, Portuguese, French and Greek bond yields all falling. Lower bond yields reduces borrowing costs, and is a blessing for countries like these with high levels of public debt.

The ECB's intervention is a noticeable relief for Italy's banking sector, which has a large amount of non-performing loans (loans that are in, or close to being in, default) and owns a lot of government debt.

There are still broader worries about Europe's banking sector though. Given the circumstances, some borrowers will inevitably default and not be able to pay off their debts owed to the banks. While the ECB has already offered ways to ease the strain, more might need to be done.

Individual countries have also stepped in with their own measures. Germany's government, for example, will raise a total of €150bn in extra debt, and is also due to set up a €500bn bailout fund to rescue companies hit by the outbreak.

Arguably, there needs to be a greater, coordinated fiscal response from all countries to replace lost wages and businesses.

How have markets responded?

Like all major global stock markets, the FTSE World Europe ex UK Index has taken a tumble this year, falling 14.8%. This compares with 13.5% for the broader global stock market.

It's not surprising to see Europe has fallen slightly further than the rest of the world, seeing as it's currently at the centre of the crisis. At this stage, there's not a huge difference, and it's possible other markets will continue to suffer if they can't limit the spread of the outbreak.

In Europe, some sectors have fared better than others. At the bottom of the performance table is the aerospace and defence sector, which has suffered the knock-on effect from stress in airline groups. For similar reasons, the travel and leisure sector has also suffered as a number of European countries are now in some form of lockdown.

Meanwhile, oil & gas companies have dealt with the blow of a falling oil price, following the Russia-Saudi standoff. Banks and other financial businesses have also been impacted due to existing concerns over the strength of Eurozone banks and their ability to withstand this crisis without sufficient support from other central banks.

On the other hand, food producers and healthcare companies, have held up relatively well as demand for food and medicines remains buoyant. So have telecoms and utilities businesses, which are typically favoured for their more defensive characteristics in times of trouble. Some technology companies are also benefiting, especially as we look for new ways to shop, communicate, and entertain.

Going forwards, volatility and uncertainty is likely to remain high around the progression of Covid-19, especially as the situation is evolving quickly. Hopefully, the rates of infection in European countries will gradually begin to flatten out. This could eventually lead to a return of domestic demand, corporate profitability and consumer spending.

Over the longer term, we think Europe has stored up potential. Some of the world's most successful companies are based there, and some carry out businesses worldwide, providing exposure to global markets

What this could mean for investors?

Now could be a good time to check if your portfolio still matches your investment objectives and attitude to risk. It's never nice to see the value of your investments go down, but we still think investing in the stock market is a way to try to grow your wealth over the long term. There's always a chance you could get back less than you invest though, and volatility is almost a certainty when it comes to the stock market.

Importantly, investors should make sure they maintain a diversified portfolio, whether by fund, geographical area, or type of asset (including the likes of shares, bonds, property, gold or cash). By holding investments with different drivers of returns, you could reduce the chances of them all performing the same way.

Wealth 50 funds

We have a number of active European funds on the Wealth 50. Funds fully invested in the stock market are unlikely to escape big market falls, but each one takes a different approach. This means they'll perform differently in different market conditions, and take different actions depending on market movements. These should be held as part of a diversified portfolio and they won’t be suitable for all investors. You should consider your own objectives and portfolio when choosing where to invest.

We consider the views of some of our preferred European fund managers, and how their funds have performed throughout the recent volatility. For more information, please refer to the Key Investor Information for each fund.

Barings Europe Select

This fund has a bias towards small and medium-sized European companies. Smaller businesses don't tend to hold up as well as larger and more stable firms when market conditions are weaker. That's been the case so far this year, which means most funds investing in European smaller companies have fallen further than the FTSE World Europe ex UK Index which is mainly made up of larger firms.

Barings Europe Select has fallen 20.3% so far this year. But, it has successfully cushioned some of the losses of the broader market of European smaller companies (-29.7%) and the average fund in the European Smaller Companies peer group (-24.4%) (source: Lipper IM, 31/12/2019 – 26/03/2020). This fits the fund's longer-term performance profile, as it has tended to hold up better in falling markets and delivered exceptional long-term returns. We still think smaller companies offer significant long-term growth potential, but they're higher-risk and more volatile, especially over shorter periods.

The recent stock market falls means a number of companies are now smaller in size than they once were and have fallen into the managers' investment universe. This could bring new opportunities to invest in high-quality companies that were previously too large to consider for the portfolio.

The managers recently made a new investment in Huhtamaki. A leader in ecologically friendly packaging solutions based in Finland – 66% of the materials it uses to make its products are from recycled sources. The company is also benefiting from large sales and growth in emerging markets.

Feb 2015 - Feb 2016 Feb 2016 - Feb 2017 Feb 2017 - Feb 2018 Feb 2018 - Feb 2019 Feb 2019 - Feb 2020
Barings Europe Select 10.9% 26.1% 18.1% -3.7% 5.9%
FTSE Developed Europe Small Cap 2.6% 24.9% 15.8% -7.0% 5.8%

Past performance isn't a guide to the future. Source: Lipper IM, to 29/02/2020.

Find out more about the fund, including charges

Barings Europe Select Key Investor Information

Threadneedle European Select

David Dudding and Benjamin Moore think the coronavirus situation could push some countries, like Italy, into recession. But they see the impact of the virus as one-off in nature and over a longer period they think economies will get back to normal.

Ultimately, no one has any strong insight into how things will pan out. The managers remain focused on the same strategy they've used for many years, investing in businesses with resilient business models and an advantage that keeps them competitive compared with their peers.

They don't tend to make changes to the fund based on economic shocks like this, instead preferring to focus on the underlying, longer-term prospects of each business. For now they've slightly reduced investments in companies with exposure to conferences and exhibitions, which are likely to see lower demand. They’ve also previously increased exposure to high-conviction luxury and consumer companies, which they'll consider adding to again at lower prices.

The fund's held up better than the FTSE World Europe ex UK Index so far this year. Avoiding some of the worst-affected sectors, such as banks, energy, travel, and leisure has helped. In particular, avoiding airline, restaurant and hotel companies, as well as retailers that have been less effective at moving their business online. Individual companies that have held up better include biotechnology firm Lonza and pharmaceutical company Novo Nordisk.

Feb 2015 - Feb 2016 Feb 2016 - Feb 2017 Feb 2017 - Feb 2018 Feb 2018 - Feb 2019 Feb 2019 - Feb 2020
Threadneedle European Select -0.2% 18.8% 13.9% -2.5% 12.2%
FTSE World Europe ex UK -5.2% 27.3% 12.7% -3.3% 6.5%

Past performance isn't a guide to the future. Source: Lipper IM, to 29/02/2020.

Find out more about the fund, including charges

Threadneedle European Select Key Investor Information

TM CRUX European Special Situations

TM CRUX European Special Situations has underperformed the FTSE World Europe ex UK Index so far this year. It held up better than the market until mid-March, but has since fallen back, partly due to its investments in higher-risk small and medium-sized companies. These have been weaker than larger firms, particularly in recent weeks.

Over longer periods, we expect the fund to hold up better in more turbulent markets, which it has done in the past, and Richard Pease, the fund's lead manager, maintains one of the strongest records in the European sector. Remember, past performance isn’t a guide to future returns though and this fund is quite concentrated with smaller and medium size companies. It increases performance potential, but also adds risk.

Richard Pease and co-manager James Milne think a large part of the recent market falls have been fuelled by panic and irrational selling of stocks, even though some companies could hold up and perform well over the longer term. As a result, they've used this as a chance to add some new companies to the fund, whose shares they think are under-priced and could bounce back once markets stabilise.

LVMH, owner of brands including Louis Vuitton and Moet champagne, is one of the fund's new holdings. The managers think the luxury goods company has a strong balance sheet and are encouraged by the fact it's historically bounced back well from temporary setbacks in consumer demand. They’ve also invested in Airbus after a significant fall in its share price. In their view, the aerospace company benefits from recurring revenues, a good level of cash, and a strong book of orders over the next seven years.

Feb 2015 - Feb 2016 Feb 2016 - Feb 2017 Feb 2017 - Feb 2018 Feb 2018 - Feb 2019 Feb 2019 - Feb 2020
TM CRUX European Special Situations 3.9% 26.0% 14.6% -8.9% 5.7%
FTSE World Europe ex UK -5.2% 27.3% 12.7% -3.3% 6.5%

Past performance isn't a guide to the future. Source: Lipper IM, to 29/02/2020.

Find out more about the fund, including charges

TM CRUX European Special Situations Key Investor Information

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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