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Regional Outlook – Europe Dominic Wallington Chief Investment Officer & Chief Executive Officer RBC Asset Management UK Limited European stock markets have had a good run from the lows in September 2011, due to a stronger global economic backdrop and more comprehensive liquidity provisions for periphery sovereigns and banks. This run in markets appears to have matured, and recent news flow on the strength of the European economy indicates pockets of weakness. Somewhat predictably, the political and market environment has deteriorated as well. The election in France has created political uncertainty, and the strict adherence of Spain to an ambitious austerity plan has led to substantial economic contraction and fears of a deflationary spiral. Investor concern for the Eurozone has grown because there is still a widely held belief that the risk of contagion from the countries undergoing austerity to those in better health remains a problem that has not been fixed. What is clear is that market pain is pushing European policy change, and more is likely over the summer. There remains a political commitment to the Eurozone. This is very important – even if it is currently articulated as a somewhat dogmatic approach to fiscal consolidation. The periphery countries do not have the policy tools (such as their own currency) to offset the effects of austerity, and the resultant impact on living standards is putting the entire strategy at political risk. A more nuanced approach to dealing with the sovereign-debt problem needs to be found, and we hope that this will be realized during the course of the year. To paraphrase Churchill’s observation Europe Recommended Sector Weights RBC Investment Strategy Committee May 2012 Benchmark MSCI Europe May 2012 Energy 10.8% 11.8% Materials 9.8% 10.0% Industrials 10.7% 10.7% Consumer Discretionary 10.0% 8.9% Consumer Staples 15.9% 14.5% Health Care 13.0% 12.5% Financials 17.6% 17.9% Information Technology 4.0% 2.9% Telecommunication Services 5.0% 6.3% Utilities 3.2% 4.5% Source: RBC GAM 4467 2899 1881 1221 792 514 334 217 141 EUROZONE DATASTREAM INDEX Equilibrium Normalized Earnings and Valuations Jun. '12 Range: 1442 - 2659 (Mid: 2051) Jun. '13 Range: 1661 - 3062 (Mid: 2362) Current (01-June-12): 882 SAMPLE 1980 1985 1990 1995 2000 2005 2010 2015 Source: Datastream, Consensus Economics, RBC GAM on the U.S.: (we hope that) Europe will do the right thing, even if it comes after it has exhausted all other possibilities. Against these uncertainties, valuations remain at generation-low levels, and corporate balance sheets are in better shape than at any time during the past 20 years. Many companies in Europe have limited exposure to the problem areas, and the soft power of the region remains in engineering excellence, pharmaceutical innovation and a plethora of leading global brands. These brands extend from beer to Scotch whisky and French wine, through to clothes, watches and food. Many of these companies are experiencing tremendous growth not only in China, but in other Southeast 58 I The global investment outlook RBC INVESTMENT Strategy coMMITTEE Summer 2012
Regional outlook – Europe • Dominic Wallington Asian countries such as Thailand and South Korea, all the way round the world to Latin America. In other words, there are many props to the growth that they are exhibiting through customer diversification and geographic expansion. This remains an important investment theme, and our portfolio has exposure to a large number of these types of companies. From BMW, the car manufacturer, to Diageo, the owner of Johnnie Walker, to Swatch, the attractively valued owner of the Omega watch brand, and Henkel, home to Persil and Loctite, we are capturing the benefits of the industrialization and urbanization trends that are taking place in many parts of the world. Even if the domestic problems in Europe continue to worsen, the area represents a viable destination for investors wanting exposure to themes playing out in other parts of the world. In the Consumer Discretionary sector, our preference is for niche consumer services-related companies with strong market-leading positions, particularly in gaming. Such stocks should perform well in a low-growth environment. In the auto sector, we have a focus on premium market German manufacturers with global exposure. In Consumer Staples we bought Diageo during the quarter. We expect robust growth in spirits consumption in emerging markets, and this company provides us with exposure to increased global luxury spending without the heady multiples seen in luxury consumer durables. The Energy sector still trades at a substantial discount to the overall market and offers an attractive dividend yield. Sector valuations discount oil prices that are significantly below current levels. Within the sector, our preference is for oil services, which should continue to benefit from a significant increase in capital expenditures by the oil majors and exploration and production companies. The banks remain a market-based barometer of the Eurozone crisis. We believe that the era of super-normal profits for the sector is over, and that returns will be much closer to the cost of capital both because of legislation and because of the need for many banks to deleverage their balance sheets. The insurers have similar dynamics to the banks, but have, in general, been less volatile. In a low-growth world, the Health Care sector’s strong balance sheets, robust cash flows, low earnings volatility and increasing focus on capital returns are an attractive combination. Little future R&D success is factored in. Our preference within the Industrials sector has been for secure growth, and for companies offering returns that are high and stable. Within Industrials, the principal area exhibiting positive earnings and operational momentum is aerospace and defence. Within Information Technology, we view software makers as later-cycle and beneficiaries of increasing corporate spending over the coming years. After underperforming during the first decade of the 2000s, expectations remain relatively low and managements are demonstrating a higher degree of capital discipline. Balance sheets in this sector are particularly robust. In the Telecommunication Services sector, our focus is on cable operators. We see excellent cash generation from these companies, and prospects for high and increasing shareholder returns. The Materials sector is exposed to the global economic cycle, and mining companies have performed poorly because investors are beginning to realize that China may have finished its big infrastructure push. We have added to holdings of chemicals companies because many of the themes that have plagued this industry over the last 20 years have begun to disappear. The supply of many products is still quite tight relative to demand, and pricing is therefore more robust than in previous cycles. SAMPLE The global investment outlook RBC INVESTMENT Strategy coMMITTEE Summer 2012 I 59
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The Global Investment Outlook RBC I
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Contents Executive Summary 2 The Gl
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Executive summary • Sarah Riopell
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Recommended Asset Mix Asset mix - t
Page 9 and 10: Recommended Asset Mix Balanced Asse
Page 11 and 12: Capital markets performance • Mil
Page 13 and 14: Global Investment Outlook Eric Lasc
Page 15 and 16: Global Investment Outlook • Eric
Page 37 and 38: Global Fixed income markets • Soo
Page 45 and 46: Currency Markets Dagmara Fijalkowsk
Page 47 and 48: Currency markets • Dagmara Fijalk
Page 57 and 58: Regional outlook - U.S. • Ray Maw
Page 59: Regional outlook - CANADA • Stuar
Page 63 and 64: Regional outlook - Asia • Yoji Ta
Page 65 and 66: Regional outlook - emerging markets
Page 67 and 68: Eric Lascelles Chief Economist RBC
Page 69 and 70: This report has been provided by RB
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