By Chris Konstantinos, RiverFront Investment Group Director of International Portfolio Management
I recently returned from a two-week visit in the UK, meeting with strategists, economists and the management teams of over twenty public European consumer companies in banking, automotive, food, retail, media, travel, real estate and construction. My purpose was to divine what sort of changes in behavior the British referendum vote has wrought, as well as to get a ground-level view of how consumers across Europe are faring in this tumultuous year. Given our portfolios’ preference for consumer stocks within Europe, we view the findings as an incrementally positive indicator for our current positioning.
1. EUROZONE CONSUMER: ENCOURAGINGLY RESILIENT (MOSTLY)
The biggest takeaway from my trip was the resilience of the European consumer, with particular strength noted in the UK and Spain, and stability in Germany and Italy. With all four regions reeling over political and banking concerns, we find our positive channel checks encouraging (see Appendix on page 3 for more specific color from our meetings). We think this resilience is related to improving employment, low oil prices, and cheap available credit. France was clearly where commentary was most pessimistic, likely related to terror events and a general malaise in the economy. Our findings are corroborated by strong post-vote retail sales volume growth in the Eurozone and September readings of retail confidence surveys taken by The European Commission (see chart below).
2. THE UK CONSUMER: KEEPING CALM AND CARRYING ON
Given the fallout over Britain’s unexpected vote to exit the EU, the strength of the UK consumer this summer is downright surprising to many. Consumers appear to be “keeping calm and carrying on.”
While sentiment has been damaged by the referendum vote, actual British consumer demand for goods appeared to be robust, according to our channel checks. Why? More than one executive I spoke with reminded us that outside of London, the rest of Britain essentially voted for Brexit, suggesting many consumers are not fazed by the vote’s outcome. Prime Minister Theresa May’s quick appointment was also seen as a positive, as she is generally viewed as pragmatic and level-headed (in contrast to some political leaders in the “Leave” camp). Other potential factors include favorable summer weather in Britain leading to greater foot traffic, continued low UK unemployment levels, and increasingly accommodative policy by the Bank of England.
Another factor to consider is the effect that a weak pound has had on inbound tourism. The New West End Company, representing Oxford, Bond and Regent Street retailers in London, reported spending from the US and Chinese tourists increased 74% and 65% month-over-month, respectively, in August. Average Chinese spending was an eye-opening £1453 per person, with luxury sales up 19% year-over-year. However, weak currency can also impact margins, and we expect this current environment will prove to be difficult for many smaller UK retailers who cater domestically and are sourcing product in USD.
3. UK REAL ESTATE: MIND THE GAP (DOWN)
In contrast to retail spending, however, UK real estate appears to us to be a pressing concern. London housing, cooling even before the vote due to stamp tax hikes, now appears to be in a bear market in certain segments, though lack of supply probably means less extreme downside than mega-bears believe. UK commercial real estate trends so far appear more resilient than residential, as rents haven’t moved much yet (See comments in Appendix on page 3). However, commercial real estate is likely to come under greater scrutiny in 2017 when actual Brexit negotiations start to profoundly color business sentiment.
To that end, data suggests that business sentiment in the UK has recovered after a sharp spike down right after the vote. But if I hoped to return stateside with uniformity around how businesses were thinking about Brexit risk, I left empty-handed. To paraphrase the European head of one of the world’s largest corporate banks, “no one actually knows what it means…but when [Article 50] gets signed, it will be a different story”. Analyzing PM May’s unequivocal statements on immigration policy over the weekend and movements in sterling, it would appear the market believes the likelihood of a hard Brexit (i.e., Britain leaving the customs union and single market) is increasing. But, we would caution drawing too many conclusions yet, with so many chapters yet unwritten. It’s probable that the definitive answer to what Brexit will actually look like will take years to reveal.
4. EUROPEAN BANKING RISKS: POOR FUNDAMENTALS… BUT UNLIKELY TO BE SYSTEMIC, IN OUR VIEW
As bears on European bank equities (see Weekly Views from 8/30/16, 7/11/16 and 6/13/16 for more on our view of European banks), perhaps we are just indulging in confirmation bias, but I found very few encouraging data points on financials during my trip. A bitter cocktail of negative interest rates, slow economic growth and the continual need for increased capital buffers have made bank valuations a moving target. One banking analyst I spoke to said that current fundamentals of the European banks reminded him of the Japanese “zombie” banks of the 1990’s, and he believes that earnings revisions should stay solidly negative for the foreseeable future.