Beyond Bulls & Bears

European Equities: Beyond the Headlines

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It’s fairly easy for investors to find reasons to shun European equities. While struggles in some Eurozone “periphery” countries continue to make eye-catching headlines, the broader story of Europe is far less fatalistic, according to Mutual Series® Executive Vice President Philippe Brugere-Trelat. When it comes to Europe, he says one shouldn’t throw out the baby with the bathwater, so to speak. He’s finding good opportunities in many places there for his portfolios at what he thinks are good prices, particularly when compared with the United States. He sees a number of fundamental reasons for investors to like Europe’s future prospects.

“European equities on average are still roughly 50% below their peaks and are currently priced at 12 – 13 times earnings, compared with 14 -15 times in the US.1 Particularly striking is the dividend-yield, the average dividend yield for European equities is 3.6%, versus 2.1% in the US. 2 There are many good companies in Europe with strong balance sheets at attractive prices, paying good dividends. The obvious push-back is the argument that, of course, European stocks are cheap for good reasons: there are terrible things happening in Europe and Europe is in crisis. I think that is total nonsense. The euro isn’t likely to disappear. The central bank is making sure there will be little chance of financial panic in the system. As we see it, the tail risk in Europe from a macro point of view has fallen dramatically.

“European corporations appear to be in good health. Labor costs are declining, and most companies have been managing costs pretty aggressively, which leads to better margins. They have strong balance sheets and have been deleveraging for years. Europe is home to a very large number of multinational companies with a big global footprint which derive a big portion of their earnings from outside of Europe. That is helped further by a weak euro, which makes their exports competitive.

“And unlike in the US, where the central bank is talking of “tapering” its asset purchase program, the interest rate environment will likely stay accommodative in Europe for some time. The European Central Bank’s president has reaffirmed monetary policy will remain accommodative as long as necessary.”

Many investors don’t see or hear the story of the significant macro adjustment that has taken place in Europe, says Brugere-Trelat.

Philippe Brugere-Trelat

“Labor costs have fallen between 10 – 30% in the ‘problem’ countries, which are becoming more competitive. Exports are also rising. Some countries have seen significant turnarounds in their current account balances. For example, Italy has a primary surplus and has passed a balanced budget amendment.

“In addition, Europeans are realizing austerity alone is not the only solution and growth is needed. I’m confident after the German election in September we will see progressive measures implemented. I think we are reaching an inflection point in European economic activity that could lead to positive earnings surprises, maybe not in 2013, but in 2014. Some recent economic indicators have turned positive or are rising, such as industrial production, retail sales, auto registrations and consumer confidence.

“I am not expecting any great fireworks as there are problems to be addressed, particularly in the banking sector. But I think earnings expectations are so low, even a modest improvement will have a profound impact on European equities. People will focus on short-term problems in places like Portugal right now, for example, but we have to take a longer-term view and look at all the data with a clear and rational mindset.”

Finding Value in Europe

Where is he finding value in Europe? He favors multinational industrials and insurance as well as retail, particularly in the UK, where consumer spending has been rebounding.

Part of the Mutual Series’ approach is to look for values across the globe, and in that context, Brugere-Trelat says he’s “pretty optimistic” on equities overall and is snapping up bargains wherever he can find them. In particular, he’s finding value in global industrial and cyclical stocks, and even in some fallen stars in the technology world.

One place he’s not finding value in right now is Japan. Investors have been flocking to Japan this year amid Japanese Premier Shinzo Abe’s new policy plan to ignite the slumbering economy. The plan, which market watchers have dubbed “Abenomics,” includes fiscal stimulus, aggressive monetary expansion and structural reforms, the promise of which has helped drive Japan’s Nikkei 225 stock average up some 40% year-to-date through mid-July. While he admits he may have missed out on some of the fruits of Japan’s market, Brugere-Trelat cautioned investor enthusiasm could prove a “short-term fad” driven primarily by speculators, and is in wait-and-see mode for now. [php function=1]

“We are very wary of what’s happening in Japan. If you look at the results of Japanese companies, I don’t see any great impact yet from the monetary policy actions. Many of the big exporters have more of their production outside Japan, so they are not directly benefitting from the low yen.”

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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. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. Current political uncertainty surrounding the European Union (EU) and its membership may increase market volatility. The financial stability of countries may increase the economic risk of investing in companies in Europe.  Value securities may not increase in price as anticipated or may decline further in value.

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2. Ibid.

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