Europe is a mess – a debt-riddled, uncertain, economically challenged minefield of risk. Investors should steer clear, right? Wrong, say the panelists in this month's Virtual Water Cooler. In an e-mail discussion with Globe reporter David Parkinson, two experts on European investing point to cheap stocks and pockets of opportunity...
DAVID PARKINSON: Can you give me one good reason as to why, as a retail investor, I should buy any European stocks right now?
EDMUND SHING, head of European equity strategy, Barclays Capital (London): If you are a long-term retail investor (investing horizon of years not months), then there are two reasons: 1) valuation, and 2) Europe is not condemned to recession, contrary to the consensus.
Dividend yields are extraordinarily high at 4.5 per cent for this year, to rise in 2012, with those dividends very likely to be paid given strong cash flows and balance sheets of most dividend-paying companies. Even if you do not want to take the risk in buying ordinary equities today (believing that P/Es [price-to-earnings multiples]could compress even further), then a retail investor can still invest in the dividend streams of Euro STOXX 50 companies via an ETF [exchange-traded fund] buying exposure to dividend futures for this index. Or one can simply invest in a sector like the telecoms sector, which currently yields over 9 per cent, and again whose dividends should in general be paid out this year and next.
While certain indicators like PMI [purchasing managers’ index] surveys point to recession, other leading indicators are not so pessimistic, while hard activity data to the month of August has actually, in general, surprised to the upside. So while undoubtedly there is a long road ahead for European countries in terms of deleveraging at a government level and improving productivity via structural reform, not all is so bad.
MARTIN COBB, executive vice-president and portfolio manager, Templeton Global Equity Group (Toronto): When Sir John Templeton was ever asked, “Where is the outlook the best, where are the prospects the brightest?”, he would respond by saying that you're asking the wrong question. Rather, an investor should ask where is the outlook the worst, where are the fears the greatest, where does pessimism abide. There you will find the greatest bargains to be had.
DP: Is now the time, then, to be looking at snapping up some of these bargains? Or are we still likely to see even cheaper prices, even lower P/E multiples, even higher dividend yields? Are we being fully compensated yet for the risks the European markets embody?
MC: We should have no confidence that valuations or share prices have indeed troughed. That is the nature of investment. It's an uncertain world and will always remain so... there are just periodic bouts when investors seem to forget that.
Will the headline indices fall further? Possibly. But we don't invest in the index but rather a select number of individual businesses. What one can say, today, is that there are ample opportunities to invest in companies whose combination of valuation and business prospects are compelling regardless of what macroeconomic environment prevails.
ES: I would also add that I believe European equity markets now price a recession, which in my view is far from a done deal. I would also agree that these valuations do not integrate the fact that many European large- and mid-caps are in fact, world-leading companies in their niches with impressive profitability records, very solid balance sheets versus history, and strong exposure outside the euro area.
Investors are in many cases “throwing out the baby with the bathwater” in their rush to de-risk (European insurance companies being prime culprits here), giving excellent opportunities to buy great-quality European companies who have been unfairly tainted with the euro area debt-crisis brush. Note the sharp underperformance of mid- and small-caps in Europe versus mega-caps since June, despite the heavier weighting of mega-cap indices in financials. … Liquidity has gravitated to the mega-caps as a “safety first” measure, driving mid-cap valuations in many cases to very low levels.
Even if one is suspicious of the euro area, there is no reason to completely snub the U.K. and Switzerland too, which make up over one-third of European equity capitalization.
DP: What do you think, Martin? Where do you see pockets of interesting European opportunities – where, as Edmund says, the baby has been tossed out with the bathwater?
MC: PIIGS says it all, really. Whilst there was previously some doubt as to whether the acronym had one or two I's, that debate is firmly over now with Italy's inclusion.
As “pessimism” investors, we have found our gaze drawn increasingly south towards the Mediterranean countries (Ireland somewhat spoils the picture). I'm not saying you necessarily buy stocks with domestic exposure to those countries but, as Edmund highlights, you don't have to in Europe.
That being said, we have identified, amongst others, a retailer in Greece (Jumbo SA), an asset manager in Italy (Azimut Holdings SpA), a cable business in Portugal (Zon Multimedia SA), a hotel group in Spain (Melia Hotels International SA) – all small-cap – who may well emerge from this crisis in a stronger competitive position than when they entered it, and whose stock prices [reflect]nothing but continued dire economic conditions.
Be fearful when others are greedy and greedy when others are fearful. It's time to be greedy.
This discussion has been edited and condensed for publication.