The backend of 2019 could offer very interesting opportunities in European small and mid-cap companies

Although markets started 2019 strongly, it was with thin volumes as investors adopted a “wait and see” approach due to uncertainties, particularly the US China trade war. Despite this, markets were remarkably resilient, with investors brushing aside bad news and buying on weakness. Q1 reporting was generally good for the market. Interestingly many of the companies that reported profit warnings in Q1 for 2019 were in fact up on the day, showing how oversold the market had become in 2018.

Monthly Fund Commentary
News
1 Aug 2019

Although markets started 2019 strongly, it was with thin volumes as investors adopted a “wait and see” approach due to uncertainties, particularly the US China trade war. Despite this, markets were remarkably resilient, with investors brushing aside bad news and buying on weakness. Q1 reporting was generally good for the market. Interestingly many of the companies that reported profit warnings in Q1 for 2019 were in fact up on the day, showing how oversold the market had become in 2018.

Market uncertainties from Brexit, global trade agreements and the relentless slowdown in global manufacturing data have driven down EPS expectations globally, however all this was overshadowed by the change of tone from major central banks. As data points drifted downwards in 2019 central banks became more dovish delaying rate increases and showing willingness to be flexible. The Fed has guided towards a possible July rate cut and the ECB guided the market towards an easing of policy over the coming months. More generally, across the globe, central bank communication has a more dovish bias. The perception of greater central bank activism provided a degree of confidence to the market after a sustained period of deterioration in macro activity data. Despite this market expectations are for more volatility in the coming quarter.

The prevailing and continuing uncertainty however puts corporate activity on hold, slows down capital spending and prevents a flow of M&A transactions, despite historically low interest rates. Q2 reporting could be more difficult than Q1. There are projects, quotes, and requests around, but they have so far failed to convert into real orders. Most corporates anticipate a back end loaded year, certainly now more than before. This should present strong buying opportunities after the Q2 reporting season which should enable investors to benefit from the weakness of Q2, but also the perceived strength of the back end loaded year.

Repeatable and disciplined investment processes
Bertrand Faure’s team have been successfully managing money for the past 17 years. Their method of combining 360 degree private equity style fundamental analysis with a disciplined investment style has proved very successful. Bertrand’s team are looking for something special in each company that makes it into the portfolio, a standard that is possible given the breadth of the European small cap universe. A typical investment is in a great business that has defendable market share and pricing power, significant free cash flow and strong management. Management really is key; Bertrand believes you shouldn’t invest in smaller companies without meeting them.

The team have built a very large database of proprietary financial models over the past 17 years, which are consistently updated. This is a significant commitment, but opportunities can be short lived. You need to be ready when the opportunity presents, not start doing the research, as the opportunity will have passed.

Fundamental analysis is combined with risk management, looking at the downside as well as the upside, to arrive at the entry and exit levels for each stock prior to it being established, while position weightings ensure that investors capital is put to work where there is most to gain and the least to lose.

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The views and statements contained herein are those of Pascal Investment Advisers SA in their capacity as Investment Adviser to the Fund as of 23/07/2019 and are based on internal research and modelling.