Market Memo: Vive la France!

10-24-2017

So much has been going on in the U.S.—new market highs, progress on tax reform and another good quarter for profits so far—that it’s been easy to overlook the good, and not so good, across the pond. During a visit last week to France, I came away encouraged by prospects for reforms there, concerned that Brexit won’t go well for the U.K. and appreciative of our country’s embrace of the tech revolution that Europe seems to have totally missed. I also continue to be impressed with the high quality of the management teams overseeing many of Europe’s greatest companies. Almost across the board, their forward prospects look pretty good as we peer into 2018.


Macron a confidence booster
French President Emmanuel Macron clearly has improved the mood and overall confidence of businesses, if not the people of his country. But—and this sure sounds familiar—everyone is waiting to see what he actually gets done. Macron has set an aggressive agenda. He wants to liberalize stifling labor laws that push up unemployment, rein in taxes and encourage more entrepreneurism, cut state spending and privatize government-run enterprises. At the same time, he’s attempting to elevate France’s status as an EU leader, partly by pushing for changes aimed at propping up European trade by taking on U.S. and other global companies on its shores. Virtually every management team I met with had a “we’ll see’’ attitude about his prospects. It seems everyone has been so beaten down for so long by the French government that their expectations are not excessive. My guess is Macron will exceed them.

Brexit negotiations will continue to be difficult for the UK
As for their neighbor across the English Channel, few of the French we spoke with had much sympathy for the Brits—a view reflected in Macron’s quick dismissal of U.K.’s offer of a 20 billion euro “divorce’’ contribution to cover outstanding commitments Britain had made to the EU. EU authorities have put those costs at 60 billion euro or higher. The British news coverage I watched at night evidenced rising frustration with Europe from the British side. We are entering the heels-dug-in stage. Europe is prepared to move forward without the Brits, and Paris and Germany are picking up incoming businesses from the U.K. as the exit process proceeds. Meanwhile, a weakened Prime Minister Theresa May is finding it difficult to put on a unified front amid bickering within her Conservative party, not to mention resistance from the opposition Labour party and infighting among members of the House of Lords.

'New Tech' in short supply
As our meetings progressed, it became more and more apparent just how far Europe has missed the “new tech” revolution. The evidence was everywhere. Companies we met with were often obsessing over Apple, Google, Facebook and Amazon. Uber has taken over the streets of Paris. Netflix and company are threatening France’s traditional television industry. This may help explain why the antitrust movement against U.S. companies is so strong in Europe—it may be one of the few ways it can slow the Yankee invasion. Macron has taken a different tack, pushing a proposal for a new EU revenue tax on U.S. tech companies that effectively could make it almost impossible to reduce their tax bills by shifting profits across borders. This proposal is unlikely to make it through Europe’s parliament, but expect continued pressure from the European government on America’s new technology champions. Another reason for our U.S. companies to not grow complacent is that Europe’s private sector knows they are behind—and as a result, are investing heavily to catch up.  Over the long term, my guess is they will, at least in certain niche areas that could prove very profitable for them.

Sharp management teams, solid fundamentals, positive outlooks
Finally, we were impressed in general with the quality of the management teams we met with across a broad array of industries, many overseeing companies with terrific market positions in Europe and/or globally. For sure, we had a targeted list of companies that had either already made it into our portfolios or had passed a rigorous screening process for potential inclusion. Nevertheless, the trip increased my conviction that investors looking to have diversified exposure to great companies with strong managements and solid market positions need to be sure to have selective international exposure in their portfolios. And from a macro perspective, outlooks were generally positive across the broad swath of companies we met with.

Given all this, where does Federated stand? Our international equity team continues to recommend staying underweight domestic U.K. companies and the pound but overweight Europe as a whole. That’s not to say Europe is cheap—far from it. Like markets everywhere, they’ve had a great run for sure, and the days of the early 2010s when all stocks were on sale have passed. But, on the other hand, many companies’ forward prospects for 2018 and 2019 look very good, and given this, valuations are not excessive and could even expand further. As has already begun to happen this year, stock picking will likely become more important in this environment—good for investors who have avoided the ETF craze and stuck by their active managers. So, “Vive la France!” Here’s to another leg up for the global bull market!