European markets have been quite volatile in the past few weeks. A complex political landscape combined with trade uncertainties has contributed to the recent sell–offs. The MSCI Europe Small Cap index has fallen by 15% since late April, and investors appear to be discounting further slowdowns ahead. We think the disconnect that exists between stock valuations and company fundamentals could end very soon.
This de-rating is not the result of any significant earnings downgrades, but rather due to fear over the late stage of the economic cycle and external factors such as Brexit, Italy’s budget deficit and global growth. Current multiples suggest investors are already discounting weaker earnings for the next two years. Although economic growth expectations are pointing to a softer trajectory, fundamentals look resilient. Here are a few observations to support our view:
Italy and Brexit remain an important risk, and the situation could stay gloomy a little longer. Until Italy implements its budget and more clarity emerges from the Brexit negotiations, investors could stay on the sidelines. In this context, financial markets should remain volatile.
It is worth mentioning that our investment philosophy prioritizes companies that offer above average industry growth with good free cash flow levels and strong balance sheets. Our approach has delivered good performance results in both up and down markets. We believe the current market environment creates interesting opportunities.
The Global Alpha Team
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1 All returns and fund details are a) based on Series F units; b) net of fees; c) annualized if period is greater than one year; d) as at September 30, 2018 ; e) annual returns are from 03/15/2018. The index is 100% MSCI EAFE Small Cap NR USD (CAD) and is computed by Ninepoint Partners LP based on publicly available index information.
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