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Equity Letter - Europe fights back


As we saw in Japan a few years ago, all the stars are aligning in Europe. This favourable environment is rewarding those investors who had been patient or tactical enough to maintain or increase their European equity exposure.

Our focus this month is on EM Domestic-demand led markets: features, challenges & opportunities. In a volatile and uncertain economic world, investors look for countries able to deliver high and steady economic growth. The domestic demand concept seems a good answer to this need.



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For two decades –the famous lost decades- Japan was the area to forget in terms of investment. Then, in 2012, Abenomics was announced and was to be considered seriously as a game changer. Japanese profitability, helped by this Japanese moment, went through the roof and climbed back to pre-crisis levels, even though this went unnoticed by most investors. Today Europe is indeed the ultimate region of the world where profits are still very far away from their 2007 peak. Our conviction is that Europe and more particularly the Euro zone should also experience this Japanese moment, with a surge in profitability and a growing appetite from overseas investors who are discovering this new investment arena long perceived as the dead money of the last decade.

Why now? Because, as we saw in Japan a few years ago, all the stars are aligning in Europe. The euro, which used to be overvalued, has become much more competitive on a trade-weighted basis. Commodities, which Europe imports far more than it exports, are now priced more attractively. Inflation, and consequently nominal growth, is now back in positive territory. Operating leverage is at a high after years of cost cutting. Lastly, as the icing on the cake, numerous identified political risks have been alleviated. This favourable environment is rewarding those investors who had been patient, or tactical enough to maintain or increase their European equity exposure.


The parallel with Japanese equities is instructive. A scenario where European equities return the kind of profits we had ten years ago, would justify double digit ESP growth for two if not three years, starting with the current year which is shaping up to be very strong and where we are looking for a 20% increase in EPS. We don’t know how many billions we will regain, but the potential for inflows into Europe is huge, given that close to USD 100 bn fled Europe last year. Only a minor part of this has found its way back and we expect more to come.

In this kind of favourable context, double digit returns are not an anomaly and segments or themes particularly exposed to this recovery mode, such as small and mid caps, or special situations, should logically amplify the upward trend. We are well aware that risks have not disappeared. The main risk that we identify as a potential party spoiler comes from the end of the cycle in the US where earnings momentum, already at an advanced stage, may well run out of steam. However, so far US earnings have been holding up, helping markets to establish new records.

To conclude, we can summarise the current situation as “So far, so good”, and those who hold their positions should continue to reap the benefits.


Romain Boscher 

Global Head of Equities





Japan: Strides in Corporate Governance

With the Corporate Governance Code being implemented for the last two years, we see a very positive impact: 1. Management is more focused on improving capital productivity, 2. Companies are improving the corporate governance structure, 3. Management is more open to constructive discussion with shareholders, 4. ESG has begun to be the issue for the management of the corporate issuers.



As for the improved capital productivity, we see the evidence from the improved ROE relative to other developed regions (i.e. US and Europe).  This is supported by both the improved profit margin and the increased return to shareholders. Companies are now not only keen on improving profitability but also manage the balance sheet so that their entrusted capital is working more effectively, resulting into better ROE.  The total returns to shareholders continue to register all time highs and almost double the amounts of the pre-Lehman crisis period. As for the corporate governance we see improvement in the ratios of independent directors. In 2016 the ratio of independent directors jumped from 15.8% to 20.6% in the companies with March fiscal year-end.  Also the ratio of companies with 1/3 or more outside directors has gone up from 19.2% to 26.8%.

At Amundi Japan, the Active Equity team has launched the Quality Reinforcement strategy in which the fund managers and ESG analysts collaborate to engage with companies. Our engagement agenda addresses not only ESG but also financial and strategic issues to improve ROE and shareholder value. The success has been seen in the removal of the poison pill with one transportation company after several meetings with the CEO as well as the Vice Presidents of the company. In another instance with a pharmaceutical company, we have provided feedback and recommendations to fill the gap in ESG disclosure and practices. In the analyses we illustrated how the company compares against the global leaders.  The company requested us to continue involvement and we see that the company is now committed to improve ESG disclosure and key performance indicators.


Taisuke Fujita

Head of Active Equity Strategies, Amundi Japan


Special Situations: Engine for growth 


The environment of persistently modest growth is a strong driver for special situations, fuelled by both economic and financial factors. The search for growth implies the search for either top line growth (external growth, thus mergers and acquisitions) or earnings growth (economic restructuring). In addition, the acquiring companies benefit from the strong accretive impact of M&A operations on their earnings.

The current environment continues to be exceptionally supportive for M&A: persistently attractive funding conditions, record levels of cash to be invested, a weak euro and low inflation. Lastly, macro-economic factors remain one of the best long-term leading indicators of M&A activity. Recent political events in Europe should reassure investors, as they should lead to greater visibility on the economic outlook, at least in the Euro zone. 


The first months of this year have seen a strong surge in M&A activity with numerous announcements covering different sectors. Among the most significant deals, we note J&J’s bid for the Swiss firm Actelion (healthcare), the merger of Essilor and Luxoticca (eyewear); Reckitt Benckiser’s acquisition of the US company Mead Johnson (consumer) and the Peugeot/Opel deal in the automobile sector, which all testify to the numerous opportunities offered by the special situations investment theme. The volume of M&A deals in Europe was above $200bn as of end May, a figure which includes not only domestic deals but also cross border activity. France has been one of the drivers of M&A this year, along with China which continues to be very active in external growth operations (2nd biggest acquirer in Europe accounting for 21% of deals in 2016).

In this supportive environment, we have a high exposure to the M&A theme which currently accounts for 65% of our portfolio. We also have a 35% exposure to economic restructuring. This theme looks all the more attractive at present because the revival of M&A activity is generating considerable pressure on inefficiently managed companies which are being compelled to restructure their business in order to avoid becoming part of the long list of potential targets.

Estelle Menard

Co-Head of Thematic Equities, CPR

Go Domestic, Cyclicals, Growth, choose Small Caps 

With a performance of 17% year to date, Euro zone small caps have outperformed large caps by 600 bp. At a time when the consensus is turning positive on European and more specifically Euro zone equities, small caps appear to meet all the requisites: domestic and cyclical exposure and a growth bias. For the moment, the chemistry is perfect: receding political risk, a very good reporting season, positive and regular macro news flow in the Euro zone, and the return of net inflows into European equities.


Historically, small and mid caps perform very well in periods of economic recovery, both in absolute terms and relative to large caps.: The main reason for this is their higher exposure to cyclical sectors (industrials, tech, consumer discretionary) which are generating stronger profit growth than defensive sectors such as utilities and telecoms. Expected EPS growth for small and mid caps this year should once again be higher than for large caps, in line with the structural trend observed over more than 15 years. The second reason (probably closely linked to the first) is their ability to generate higher operating leverage in the event of top line growth. With PMIs at an elevated level and inflation which, while admittedly below expectations, is positive, growth forecasts are being upgraded. In addition, with their higher domestic exposure on average, small caps should benefit more from the recovery in consumer spending. They should also be bigger beneficiaries of the expected reforms in different countries, such as those anticipated in France, for example. The fall in the corporate tax rate planned by President Macron should logically be more positive for small and mid caps which pay a higher proportion of their taxes in France.

Thus, thanks to the expected leverage on earnings, the fall in interest expenses in an environment of particularly attractive interest rates, and very likely lower tax charges, Euro Zone small cap EPS could rise by roughly 25% this year, which explains the strong performance of the small cap indices. Lastly, as long as reflation anticipations remain moderate, the growth style will continue to perform well, which will be more positive for small caps than for large caps.

The low interest rate environment is also supportive for M&A operations which are proliferating in the small cap universe and are a real driver of performance. The stocks in our portfolio have already been involved in five takeover bids year to date (Zodiac, Stada, Epigenomics, Pfeiffer Vacuum and Drillisch) with premiums of up to 49% and we believe that this movement will accelerate as anticipations of an end to accommodative monetary policies gain ground. The historically high level of premiums on these operations confirms our view that valuations have not yet peaked. Despite a 12-month forward P/E of 16.6x in absolute terms, Euro zone small caps are still trading below their long-term average valuation relative to large caps (historical premium of around 25%).

In this supportive environment, we believe that small caps will remain an attractive asset class.

Caroline Gauthier

Co-Head of Europe Small & Mid Caps




EM Domestic-demand led markets: features, challenges & opportunities*

In a volatile and uncertain economic world, investors look for countries able to deliver high and steady economic growth. The domestic demand concept seems, on the surface, a good answer to this need. Defined as the sum of Final Consumption Expenditure (both by Households and Public Administrations) and Gross Capital Formation, it is supposed to isolate GDP growth from its external components (GDP = domestic demand + exports – imports + inventories change). Unfortunately, this opposition is arbitrary and wrong.

First, no country has been able to achieve its economic development by remaining closed to foreign markets as they represent a key incentive for companies and labour to improve in terms of products, innovation, skills and organisation. Second, the net trade can have meaningful influence on domestic demand itself. A more relevant question is probably whether economies less sensitive to the global cycle, including natural resources, exhibit more steady economic growth and on which economic features it rests.

Domestic demand shows less volatility in economies less sensitive to global cycle

What are the benefits to corporates and investors? Our analysis show that economies less sensitive to the global cycle exhibit a more steady economic growth. The volatility of their domestic demand has been consistently lower than in economies more sensitive to external global factors. In turn, it improves the ability of the corporate sector to develop long term business plans, including research and development, capacity expansion (including infrastructure) or organization efficiency. The banking sector also enjoys more visibility and is able to provide long term financing, a key factor to help companies’ financing. Overall, countries with  a more stable domestic demand enjoys a higher Fixed Asset Investment to GDP, which again is required for long term development.


Lower volatility of domestic demand for non-commodity exporter economies



Volatility of domestic demand is consistently lower in non-commodity exporting countries



Lower volatility of domestic demand generally translates into lower volatility of equity markets

The investment opportunity continually offered in domestic demand led markets can be seen in the number of IPOs that these markets have witnessed in the recent years. Reflecting innovation and productivity gains, both the equity markets’ breadth and total market capitalisation have increased in response, highlighting investors continued interest for these dynamic corporate sectors in the economies. Between 2002 and 2017, the number of listed companies with a daily volume above USD 1mn have increased 7 times in India, Thailand and Philippines together, whereas the increase was only 4 times in Russia, Brazil and South Africa, despite a commodity boom in the meantime. This dynamism also translates into an incremental benefit for equity investors: these markets tend to be more diversified with a growing weight of small and mid-caps companies. 

Number of listed companies in selected markets in 2002 and 2017


Higher diversification illustrates economic dynamism and wider opportunity set


As shows the bottom left graph below, we have found that stable domestic demand translates into equity returns with lower volatility, all other things kept equal. Moreover, risk adjusted returns have been better on average for domestic demand-led markets. This has been a clear pattern over the last 15 years, and which we would expect to continue in the years to come.

Lower volatility of domestic demand generally translates into lower volatility of equity markets


Better risk adjusted return on average for domestic demand-led markets since 2002




*Extracted from Emerging Markets Academy


Mickaël Tricot

Deputy Head of Emerging Market Equities

BOSCHER Romain , Co-Head of Equities
MELHUISH Nicholas , Chief Investment Officer, Equities – Amundi London
LEMONNIER Patrice , Head of Emerging Markets Equities
IWANAGA Yasunori , CFA, CIO Amundi Japan
DRABOWICZ Alexandre , Deputy Head of Equity
ANDRE Sudeshna , Investment Specialist, Equity Strategies

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Equity Letter - Europe fights back
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