A series highlighting news and trends in international business that matter to investors looking for opportunities outside of Canada.
What an opportunity. Trading was halted in China and all across Europe stock markets were tumbling. The atmosphere on the trading floor was electric, crackling with anticipation. North American markets opened and down they went. Germany's DAX index, which had climbed back from its September rout, cracked and was falling precipitously. Britain, France, Spain, Italy, Switzerland – all down.
The euro, which had bounced back from a November low, turned around and was heading south again. Oil prices slid to new cyclical lows.
Fund managers focused on Europe were rubbing their hands. What could be better?
The early January market selloff may have frightened some investors, but many of the pros were picking over the ruins looking for bargains. Why? Because European stock markets are forecast to outperform again in 2016, according to a recent Reuters poll of U.S. money managers. The consensus is for a gain of roughly 10 per cent by mid-year. That would still leave them below last April's peak, when the pan-European STOXX 600 index hit 415 and Germany's DAX 12,390.
At Mawer Investment Management Ltd. in Calgary, investment strategist Kara Lilly, like many other portfolio managers, had been waiting for a chance to spice up her holdings, but European markets were still relatively expensive.
"We're keeping our eyes open right now," Ms. Lilly says in an interview, just before the recent market meltdown. "We keep an inventory list with thousands of companies that are not in our portfolio but that we may want to hold some day, waiting for some factors to move in our favour," she adds.
Mawer has lists "for a large number of names," including companies in Spain, Ireland and Italy. "We're very patient."
Price, or valuation, is only one factor Ms. Lilly considers. Mawer is a fundamental, bottom-up stock picker. "There are a handful of factors that we're looking at," Ms. Lilly says. "It boils down to a wealth-creating business model, the price, the management. … There are a number of companies in the world we'd love to own but we just can't agree with how management runs their business" – such as buying expensive jets and giving themselves big bonuses, she adds.
The European economy is three or four years behind the U.S. economy, but it is following the same path, the fund managers say. The European Central Bank is still dishing out money freely.
"Europe bounced out of recession in late 2014, up to a rip-roaring growth rate of about 1.5 per cent, which is good for Europe," says Drummond Brodeur, a global investment strategist at Signature Global Asset Management, a division of CI Investments. "There's a massive disconnect between perception and reality in the public's eye." Growth is expected to continue throughout 2016, Mr. Brodeur says. "Fiscal stimulus, monetary stimulus, structural reform; all really improve the long-term growth potential."
As earnings grow, so will dividends, which tend to be more generous in Europe than in North America.
While the perception of the stock market is bearish everywhere, "the reality is economies are working, earnings are growing, stock markets are reasonably valued but not cheap," Mr. Brodeur says. Behind the forecast strength is the big drop in the euro against the U.S. dollar, which should prove a boon for big European exporters, the analysts say. The euro dropped from about 1.40 to the U.S. dollar in May of 2014, to about 1.09 at publication time. Some forecasters are calling for parity with the greenback before the year is out.
European exporters stand to benefit.
Ms. Lilly of Mawer points to pharmaceuticals and consumer health companies, whose stock prices may be hurt by the headlines "but the underlying business is still good."
At the same time, energy prices have been slashed, which also stands to benefit European companies. "The move in currencies and commodities was the single biggest defining factor for European economies last year," Mr. Brodeur says. "Those tailwinds will continue into 2016," he adds. "Lots of companies could be very competitive at these exchange rates, companies such as Nestlé, Diageo, Denon, all the luxury goods companies."
Citizens of countries such as Greece and Spain are pushing back against austerity, so fiscal policy will become more stimulative, he predicts. As it does, consumer confidence will improve. Banks, too, have begun lending again, although there's not a lot of demand.
Of particular note, Mr. Brodeur says, is Italy, which is attempting serious reforms. "They're trying to undo everything Italy has done in the past 40 years: electoral reform, labour market reform, real-estate reform, judicial reforms," he adds. "Pretty well everything is on the table."
At Fidelity Investments, Patrice Quirion has been shifting money from the U.S. market to Europe for a year or so. Mr. Quirion, who manages the Fidelity Global Concentrated Equity Fund, says the fund is now overweight Europe and underweight the United States.
While European stocks are slightly cheaper on a multiple basis, or their price-to-earnings ratios, "What I find more compelling is what is likely to happen to earnings growth in Europe versus the United States going forward," Mr. Quirion says. "European companies are better positioned to grow their earnings because the weakness in the euro [against the U.S. dollar] will create a large tailwind for European multinationals."
The flip side is that the strong U.S. dollar will be a headwind for the U.S. multinationals.
Banks, too, will become stronger as they finish their asset writeoffs. "That drag is going away this year."
Not all sectors will benefit equally from the falling euro, Mr. Quirion cautions. Exporters, industrials and some luxury consumer companies stand to benefit but not so telecoms, financials or utilities, whose clients are domestic, he says. On top of it all, Europe's easy monetary policy is gravy.
Because he invests mainly in big multinationals, Mr. Quirion looks for value in Switzerland, Britain and "to some degree in Germany" because few such companies can be found in the smaller countries. He is overweight Britain and Switzerland and slightly underweight continental Europe.
Perhaps the most compelling argument for Europe is that the European market has underperformed the U.S. market by about 50 per cent since the 2008-09 financial crisis, Mr. Quirion says. "I don't think there's anything structurally different in either market." Further, if you compared the two markets, converting them both to U.S. dollars, the European market would now be at its lowest point since at least the 1980s, Mr. Quirion says. If the U.S. economy is indeed three years ahead of its European counterpart, "that has huge implications for European GDP [gross domestic product] growth."