While the United States is entering an extended period of monetary tightening, Europe is beginning its experiment of unbridled and unrestrained monetary stimulus. One thing that investors know from the experience in the U.S. is that when central banks are being this accommodative, asset prices tend to go up. At the same time, valuations in Europe are significantly below those in the U.S. and Canada, offering investors a mid-term investment strategy for the months ahead.
Europe is back in the investment news again, but this time the headlines have been decidedly better. While Greece faces a continuing series of cash crunches, the recent extension of the country’s bailout program has given the beleaguered country a much needed lifeline. This came after weeks of increasingly tumultuous twists and turns in Greece’s debt saga, which had begun to leave market participants feeling increasingly frustrated.
So says John Stephenson, portfolio manager and president of Stephenson & Company Capital Management Inc. in Toronto. Writing in The MoneyLetter Mr. Stephenson continues:
Greece’s next cash crunch
But now, even as the ink is barely dry on the bailout agreement, there are reports that Greece may have trouble paying its bills soon. Caught between dwindling tax receipts and requirements to repay debt soon to the International Monetary Fund, Greece once again finds itself caught between a rock and a hard place.
The government changed quickly. Has anything else?
The election of the Syriza party, which took power on a promise to reverse austerity and renegotiate the country’s bailout, had raised the risk of a Greek exit from the euro zone. Alexis Tsipras was swept to power in January as prime minister on a pledge to scrap the painful austerity measures prescribed by the bailout package. Since then, however, relations between his government and the rest of the euro zone deteriorated so sharply that there have been doubts an agreement could ever be reached.
More to do . . .
But there is much more that European officials have to do. Though the Greek government secured an extension of its bailout program recently, Athens doesn’t have access to cash pledged to it from the euro zone and the International Monetary Fund. To unlock that money, it will need to agree on a revised program of austerity measures and economic overhauls with creditors, and pass them into law.
. . . but markets clearly relieved
After news of Greece’s deal with its international creditors broke on February 24, fixed income markets pared early gains, as investors shifted out of safe-haven assets. Spain, viewed by many market watchers as particularly susceptible to the rise of anti-austerity politics, saw the yield on its 10-year government bond fall five basis points, leaving it down six basis points on the week.
Meanwhile, the latest euro zone economic data suggests that investment strategies for recovery in the region are gaining momentum. The euro zone composite purchasing managers’ index rose for a third successive month in February, reaching its highest level since last summer.
Citigroup’s euro area economic surprise index is currently at its highest level since September 2013, and the gross domestic product of 18 countries that share the common currency expanded by slightly more than economists anticipated during the last three months of 2014.
Best yet, the outlook for European equities is buoyed by a potent trifecta: the collapse in energy prices, which boosts the disposable income of consumers; the decline in the euro, which will aid export-oriented firms; and full-scale quantitative easing, which will boost growth and improve business confidence.
According to Merrill Lynch, flows into European equities have increased for five consecutive weeks, totaling US$15 billion over that period. In February, some 51 percent of fund managers surveyed by the bank named the region their top pick for equities over the next 12 months.
Quantitative easing: The markets like it
Market attention has refocused on the euro zone, after Europe had fallen out of favour with global investors in the second half of last year. These days, most are following an investment strategy that will position them ahead of a period of unprecedented monetary policy that is aimed at boosting inflation and growth in the single-currency block. Global enthusiasm for the euro zone has pushed investor inflows to record highs ahead of the European Central Bank’s full-blown government bond purchases, due to start on March 9. Some $19.3 billion has poured into euro zone-exposed exchange traded funds (or “ETFs”) this year, almost double the previous record for any quarter, according to data from Markit.
Not just tourists heading to Greece
Surprisingly, Greece is seeing particularly strong investment inflows, with the sums flowing into ETFs tracking the country reaching the equivalent of 53 per cent of assets under management in the first two months of 2015—despite tense negotiations over a bailout extension.
European valuations, yields worth checking out
European companies are trading at average valuations on earnings some 35 per cent to 40 per cent lower than their previous peak, and have room for a catch-up. Not only that, but the highest yield globally is in Europe, which boasts an average yield of 3.5 percent.
The Caveat: deflation worries
Despite a brightening picture in the euro zone, companies continued to report declining selling prices in February. This suggests that the deflation threat is still alive and kicking, justifying the European Central Bank’s quantitative easing, due to begin this month.
U.S. is best, but there are opportunities in Europe
While I still believe the best long-term investment strategy exists in the United States, the opportunity in European equities over the intermediate term is undeniable and I’ve begun to allocate a greater percentage of my portfolios toward European equities.
What I Recommend
I believe that Europe is on the cusp of a gross domestic product and earnings per share (or “EPS”) “upgrade” cycle. This is good news for European equities in general, but in particular for cyclical sectors of the market, such as the financial, consumer discretionary and industrials. Economic expectations are still too low, earnings momentum for cyclicals has troughed, and valuations are attractive.
Where the new money’s flowing—and why
Equity funds have seen inflows of $15.4 billion this year as investors have become seduced by soaring European stocks that have hit record highs in recent weeks. Meanwhile, bond yields, which move inversely to prices, have plunged to record lows as bonds are snapped up in anticipation of the entry of the European Central Bank into the market.
Euro zone stocks have risen 14 per cent this year while Germany’s DAX index is up 16 per cent. Greek share prices have climbed four per cent. Funds offering broad exposure to the euro zone dominated inflows, while Germany attracted the most inflows on a country basis. ETFs tracking the euro zone have attracted larger inflows ($19.3 billion) than any other region in 2015, with the U.S. drawing $6.6 billion, the U.K. $455 million and Japan $16.4 billion.
The Eurobull is just getting started
While European markets have shown a strong move upward, there is still plenty of opportunity to adopt a medium-term investment strategy in the months ahead. The financial services sector looks particularly attractive as valuations, outlook and a strong cyclical rebound improve their fortunes.
ING Groep: Inexpensive, with clear routes for improving performance
One company that I like is ING Groep NV (Euronext Amsterdam─INGA). It offers banking, investments, life insurance, and retirement services to a broad customer base. The stock is inexpensive trading at 0.8 times 2015 estimated book value and boasts a return on equity of about 11.6 per cent.
I believe that the driver for better share price performance will be higher net interest margins, better cost control and lower loan loss charges driven by a recovery of domestic activities. As well, ING has investment stakes in two insurance companies, NM and Voya that will likely be disposed of shortly, unlocking substantial value for shareholders.
I have a buy recommendation on this stock and a 12-month target price of 14.50 euros per share.
Moncler: Unique brand, strong growth outlook
Another stock that I like is Moncler S.p.A. (Borsa Italiana─MONC). Moncler is a leading designer of high-quality down jackets (85 per cent of sales are from outerwear), which are manufactured predominantly in Eastern Europe.
Moncler offers investors a uniquely positioned brand in the luxury outerwear segment, with a highly streamlined business model and a tightly managed brand generating impressive levels of consumer demand. I believe the business can grow at a compounded annual growth rate of 16 per cent through 2017.
I have a buy recommendation on the stock and a 12-month price target of 15.75 euros per share.
Evolva: Filling health, nutrition and wellness niches
Evolva Holding SA (SIX Swiss Exchange─EVE) is a biotech firm that I like. The company’s mission is to discover and provide innovative, sustainable ingredients for health, nutrition and wellness.
Evolva’s key product is a sweetener called Stevia that is developed and distributed in partnership with Cargill. I think that there is a huge opportunity set for cultured food with Evolva holding key technology for fermentation-derived food ingredients.
I have a buy recommendation on the stock and a 12-month price target of $2.50 Swiss francs per share.
The MoneyLetter, MPL Communications Inc.
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