European Equities October 2012

Over the summer months, markets benefited from both positive and negative economic data, believing the latter simply hastened the implementation of Quantitative Easing (QE). Policymakers finally ‘got it’ and delivered a powerful response. First, Mario Draghi launched his OMT (Outright Monetary Transactions) programme to buy European peripheral bonds as the buyer of last resort. Ben Bernanke subsequently announced his plan to increase QE in order to bring down long-term interest rates, cap mortgage costs, stimulate growth and reduce unemployment. It appears that central banks are determined to avoid deflation at any costs and it looks as if asset prices can rise as a result of result of the European Central Bank’s (ECB) activity in bond markets. The banking sector stands to benefit most directly from the ECB’s actions and has risen strongly in recent weeks. The ECB’s measures will continue to support this sector and markets in general, but we are sceptical of the longer-term sustainability of a sharp bounce. This is because Europe will experience weak or negative economic growth in 2012 and growth will remain low thereafter, hindering a recovery in the banking sector’s profitability. Worse still, banks are being forced to deleverage and are subject to increasing regulatory pressure (such as the Basel III restrictions and the proposal to elevate the ECB as a super-regulator of a Eurozone banking union). But Europe is cheap on both absolute and relative measures, trading on less than 11x 2013 EPS and is 40% cheaper than the US as measured by P/BV. Despite recent strong moves in markets, the equity risk premium is still at elevated levels.

Given that cyclical stocks have rallied strongly in recent months, can they climb further?

There is good value to be found among European cyclical stocks and we are especially attracted to the better-quality, cyclical companies; this valuation support could boost any short-term rallies caused by ECB initiatives. However, we are cautious about economic prospects in Europe and, as with the banks, this tempers our longer-term enthusiasm for domestically-focused cyclicals. Pressures exerted by bank deleveraging and austerity, and the consequent impact on consumer and industrial confidence will curb investor appetite. Growth in southern Europe will be particularly weak, not just in Greece, but in Spain, Portugal, and Italy too, where weakness will also be more prolonged than elsewhere.

Can attractive opportunities be found among European companies focused on domestic markets?

In terms of the domestic market, we are cautious about Europe’s growth prospects. However, we believe that there are opportunities on valuation grounds, both among those stocks that have been oversold, and in businesses operating in particular niches, which are relatively immune from the weak economic backdrop. We focus on enterprises whose competitive position delivers robust pricing power and, therefore, strong, predictable and sustainable returns.

There is currently a strongly-held consensual view that investing in European companies benefiting from the weakness of the euro, with exposure to countries that are growing at a fast pace - emerging markets and especially China - is an attractive strategy. We held this view (which was successfully reflected in our portfolios) long before it became consensual, and it has boosted our strong performance. However, with China slowing and good valuations evident among domestic stocks, a more balanced approach is now appropriate.

Der vollständige Kommentar im pdf-Dokument