Rory Bateman, Head of European Equities, Schroders
"Europe houses some of the best companies in the world; market-leading franchises, all too eager to take advantage of demand growth across global markets. For us, there is a wealth of neglected European ‘stars', which are offering increasingly good value as fearful investors wait in the wings until the dust settles."
European equities: catalysts for change
♦ Bold policy decisions by the ECB have been viewed by many as a ‘game changer' for Europe. The measures taken are substantial and should further reduce the European equity risk premium as the tail risk event of a Eurozone break-up diminishes. Importantly we are starting to see more political and economic cohesion between the authorities and, ultimately, this cooperation will be a pre-requisite for the survival of the Eurozone project.
♦ If we take the view that any potential fallout from Greece is contained and the Eurozone will still be around in five years' time, then it makes sense to look at the euro region as one entity. Laying Greece to one side, if you aggregate all the government and household debt within the Eurozone economies, the gross debt as a percentage of GDP looks to be in decent shape relative to the US and Japan.
♦ Europe is a diverse region giving investors access to unique companies that are trading at a significant valuation discount to their global peers. Long-term European equity valuations are near historic lows as a result of the Eurozone debt crisis. Our central belief is that the euro will survive as the repercussions of a disorderly break-up are incomprehensible for the global economy. We accept that there is a possibility of a Greek default, but we feel this is largely reflected in valuations; which according to the Graham & Dodd price-to-earnings (P/E) ratio (c 13x) is close to 30-year lows.
♦ With liquidity injections driving down bond yields and eroding income, European equities offer a compelling alternative to investors on the hunt for yield. We have an environment in which investors seeking security are paying the Swiss and German governments, in nominal terms, to hold their money over a 2-year period. In contrast, the earnings yield available in the European equity market is looking increasingly attractive. In terms of dividend yield, in many cases this far exceed the yield available on the same company's corporate bond.
Conclusions
We believe the opportunities to invest in attractively-valued, unique global business in Europe are plentiful. However, good stockpicking will remain crucial if investors are to effectively capitalise on these opportunities. Divergence at the country level is wide, but investors should not allow country domicile to unduly influence investment decisions. In our view, peripheral Europe continues to house quality global franchises that do not rely on their domestic economies for growth.
We are realistic about the macroeconomic headwinds facing Europe. We expect a protracted recovery and do not imagine that we will see a dramatic improvement in growth expectations for 2013. The brinkmanship between the Germans and the southern Europeans will likely continue while the path through austerity will be long and bumpy. However, we believe the central bank actions are a game-changer. The removal, or the diminution, of a tail risk event (i.e. a Eurozone break-up) is very significant. Mario Draghi has made some very difficult decisions but, strategically, the right ones in our view.
We think that longer-term investors have the opportunity to look beyond the current austerity-driven sentiment surrounding European equities and buy interesting European assets at attractive valuation levels. The potential for sentiment to improve remains, with consumer and manufacturer confidence starting to stabilise.
Should progress continue it does not seem too difficult to imagine a scenario where successful structural reforms and austerity enable growth strategies and expansionary policy to move up the political agenda - which begs the question, ‘could the curtain of austerity be obscuring the window of opportunity in Europe?'
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