Smart money is flowing back to Europe
The continent offers plenty of opportunities to diversify into high-quality, global brands at an attractive price
By: SIMON AVERY
Date: May 14,2014
When senior executives of ABB Ltd. recently travelled from their head office in Zurich, Switzerland, to Boston to meet with professional investors, Stephen Oler and Peter Hadden were the only portfolio managers to show up. ABB may not be a household name, but it is the largest manufacturer of transformers in the world, doing $42-billion (U.S.) of business a year.
The lack of investor interest in this European industrial powerhouse is a sign of the times. Most North American investors remain bearish on the European market, with warning cries about the imminent collapse of the banking system and the looming breakup of the euro zone still ringing in their ears.
But Europe is officially back from the dead. All members of the European Union recorded GDP growth at the end of last year – with the exception of Cyprus, Finland and Ireland – causing economists to declare an end to the two-year recession in the euro zone and helping European stock markets to post gains on par with major U.S. indices. Smart money is flowing back to Europe, Mr. Oler says.
“Things had gotten so bad during the financial crisis that people were questioning the longevity of the EU itself and whether the currency would survive,” says the portfolio manager at Pyramis Global Advisors, a Fidelity Investments company. “I think we’ve put that behind us. We can pretty much bet that the EU is going to remain intact.”
Several factors are helping to reignite confidence in Europe. The most significant may be the emergence of the European Central Bank, under the leadership of president Mario Draghi, as the leading, unified voice for the continent’s economy. The ECB is preparing to become the sole supervisor of EU banks and has let global markets know that it is not afraid to circumvent EU bureaucracy to crank up stimulus if necessary.
The central bank has been pumping cheap money into the economy since late 2011. Through its Long-Term Refinancing Option (LTRO), it is lending to European banks at ultra-low rates to encourage them to invest in businesses. It has also been buying sovereign bonds in the secondary market, a move seen as the precursor to a broader quantitative easing policy that would boost stocks.
“The ECB’s next move may take it where no big central bank has gone, cutting a key interest rate to below zero,” Jean-Michel Six, the chief European economist for Standard & Poor’s, said in a recent report. Such a move would essentially penalize banks for parking money at the central bank rather than recirculating it into the economy.
“Our opinion is that this move would only be the preamble to a larger stimulus, akin to quantitative easing,” Mr. Six added.
Already, the ECB “has been expanding Europe’s monetary base and doing everything it can short of [currency] devaluation,” says Peter Hadden, who co-manages the Fidelity Europe Fund for Canadian investors.
One of the results has been downward pressure on wages in the periphery EU states, which in turn is starting to attract new business investment. Just last month, General Motors launched the next stage of a $1.4-billion (U.S.) upgrade to its plant in Zaragoza, Spain, which makes the popular Opel model.
Lower wages will also help spur the stagnant housing sector, which has not kept up with rising demand over the past five years, Mr. Hadden says. He considers Europe’s high number of unemployed a source of fuel that will gradually re-enter the economy and power a sustained bull market cycle.
Most global fund managers are still underweight in European stocks. But savvy investors have been picking their entry points into the market, buying on dips as small as 2 or 3 per cent – although 10-per-cent dips are a more conservative measure, Mr. Hadden says.
Europe represents a chance to diversify into high-quality, global brands at an attractive price today. That should be of particular importance to Canadians because the energy sector – a huge contributor to Canada’s economy – is going to face deflationary pressure as the United States and other countries intensify fracking operations in the natural gas sector, Mr. Oler says.
There have been numerous popular arguments for avoiding European stocks since the financial crisis. Just as currency fears began to subside last year, new ones emerged about deflation. Most recently, five periphery countries did report declining rates of inflation for March, but the ECB is forecasting that the overall euro-zone inflation rate will climb gradually, reaching 1.5 per cent by 2016.
Fidelity favours the consumer discretionary sector along with financial institutions. Volkswagen, for example, is benefiting from missteps by Toyota and is becoming the new No. 1 global auto company, he says. Industria de Diseno (better known as Inditex) is benefiting from Europe’s reputation as creator of the world’s best luxury brands. The Spanish company owns Zara, Stradivarius and other top brand names and is “making hay outside of Spain” in almost 90 countries across five continents, Mr. Hadden says.
European financial institutions, meanwhile, are expected this year to post their first loan growth since before the crisis. Their loan loss provisions continue to fall and their stocks still trade at reasonable price-to-book ratios, Mr. Oler says.