The European equity market is coming back to life: economic indicators in the region have stabilised and continue to improve. Geopolitical risks, at least in the eurozone have subsided and populist support is receding. Still, investors are concerned that following a 32 per cent rally since June 2016 the European equity trade may be exhausted.
What are the indicators that would point towards a sell scenario? From a fundamental perspective the answer is pretty simple. Since each equity’s market price reflects the theoretical discount of all future earnings, factors that would push downwards future earnings are the same factors that would indicate an upcoming bear market and thus a sell situation. In practice, fundamental factors, geopolitical risks, availability of information and simple chance are entangled in a chaotic net that rarely makes immediate sense.
Historically, a few common factors have been able to predict a difficult period for a company. However, it is important to keep in mind that history also indicates that large cap companies commonly recover strongly from ‘bad’ periods. At a single stock level tell-tale signs of a company which might be going into a difficult period are;
1. Loss of a key member of the organisation
Think Steve Jobs leaving Apple. Whether you see it as positive or negative, his absence affected the organisation to the extent that some investors reconsidered their investment at the time. Such a change, however, is usually only relevant when a key employee such as the chief executive officer quits with little or no notice. Even if ample time had been given by the respective figure head, one might still be sceptical, as the company might stray from its overall aims and objectives, change plans and/or alter standards. Adidas, for example was heading into a downward spiral, constantly losing market share. A change at the top led to a reversal of fortunes with the share price gaining well over 100 per cent since the change.
2. Consistently missing estimates
Every company goes through tough times, so when a firm misses earnings estimates in any one quarter, it isn't necessarily something to worry about. But when a company misses earnings estimates in consecutive quarters, investors should at least consider selling the stock and heading for greener pastures.
3. Inventories are on the rise
Basic economics implies that if a company's inventories are rising at a faster rate than its sales, it may indicate that the company is having trouble selling its merchandise. If this is the case, then consider selling the company's shares to protect yourself from future losses.
At a market level, I believe that the European equity rally is still in its infancy. The eurozone economy is starting to gear towards growth. Germany continues to steam ahead, but optimism is once more emanating from France and Spain. Italy remains a dark horse and Greece a dark cloud. But if everything comes together, the potential for above normal growth in the eurozone is present.
The EU is made up of several moving parts that do not always head in the same directions. Lethargy sometimes prevails. But this environment has also given slow movers a chance to catch up. The recent rally in European equities is not a signal to take profits, but rather the first signs of what is to be expected if stability and economic growth in the region prevail.
Disclaimer:
This article was issued by Antoine Briffa, investment manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.