Beyond Bulls & Bears

Deep Value Diving in the Eurozone

Greece’s tale of financial woe may well go down as a modern Greek tragedy, with people in power falling prey to a tragic flaw which brings about their catastrophic reversal of fortune. It’s all quite dramatic and dire, but if the real life Greek financial system stays true to the classical formula, the conclusion means recognition of that tragic flaw and potential course correction. For those hardy and/or contrarian souls who suspect opportunity may be sprouting from Greece’s great mess, this would be good news.

Among those who claim to see life rekindling amidst the ashes is Katrina Dudley, a Mutual Series® portfolio manager, and an advocate of the notion that there are seeds of (gasp!) growth—and a place for Greece—in the Eurozone.

Katrina Dudley

“If we look at what’s happened in Europe over the last couple of years, we have been positively encouraged by what Spain, Italy and Portugal have all done to address structural fiscal imbalances. What we see now is that countries in the region are realizing that they can’t cut their way to prosperity and need to now look at pro-growth policies. We are seeing very early signs of this. Now in terms of pro-growth policies, we are not talking about building bridges to nowhere. We are looking at structural reforms that will encourage companies to invest, encourage companies to hire workers.”

“From a stock-picking perspective, over the last few years most European investors have wanted to own European companies that sold their products out of the region—the so-called exporters. As value investors, we also look at domestically oriented companies, which have really been the ones who have suffered under this austerity regime. As we see these countries exploring pro-growth policies, we believe the domestically oriented companies should benefit.”

Greece is the Word

Of all the countries in the Eurozone, Greece, in particular, seems to have suffered the most. Its economy has contracted for five straight years and one index provider recently reclassified the country as an emerging market. But Dudley disagrees with that assessment, stating the definition of an “emerging market” can be a bit subjective in nature, and one her team doesn’t base on a specific quantitative metric. Among other factors, she says emerging markets are usually defined as rapidly growing countries undergoing industrialization, which isn’t the case with Greece today.

“We try to think about factors that make emerging markets attractive. We think about GDP growth rates that are greater than those in developed markets, and we also look at rising income per capita and rising wage rates. These are characteristics Greece would love to have. I think that Greece would love to be classified as an emerging market based on these criteria, but it isn’t from our perspective. Greece’s GDP is contracting, its income per capita is actually declining, and its wages are still coming down.”

The Italian Shuffle: One Step Forward, Two Steps Back

Italy has had its own share of issues, and the market took notice after its federal elections in late February didn’t produce a clear winner, interpreted by many as a vote against reform and austerity. That triggered additional turmoil in European markets and more uncertainty in an already volatile region.

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“We think that there is some risk that Italy could derail progress (in the Eurozone). But we think that the people were voting for no more austerity rather than a reversal of the measures that have already been put in place. Also, we’re very positively encouraged by the fact that they are not talking about undoing all those good regulatory, structural reforms that were implemented under [Mario] Monti’s 18-month tenure.”

Encouraging words, but it has to be noted that if Italy can’t form a government, Italians might have to head back to the polls, which would likely lead to more Eurozone volatility.

Cautiously Optimistic

Given the restraining influence austerity measures can have on growth rates, few are overly optimistic about the region’s economic prospects, at least in the first half of 2013. Still, seasoned stock-picker Dudley says she and her team have been identifying companies where they see value based on indications that corporate fundamentals have begun to improve.

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“We are cautiously optimistic that the political and economic environment (in Europe) might improve during 2013 and that company fundamentals could become more important in driving European stock prices. From our perspective, the situation remains politically—not financially—driven. Therefore, we believe a lot of work on the debt crisis remains for European leaders to carry out.”

“We think the easy money has been made in European equities, but we still see a lot of opportunities there. We still think the European market has appreciation potential. It probably won’t be a straight line; we think it will be bumpy and you will see headline risk, but we do think that the European market continues to look cheap.”

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What Are the Risks?

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.  Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.

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