It is official: Europe has slipped into deflation and macroeconomic concerns for the future of the Eurozone economy are once again top of mind. As investors closely watch the European Central Bank (ECB), what’s their take for Europe in this first part of the new year? Global Investing Insights spoke to a few.
Eric Sagmeister, portfolio manager, Forward Dividend Signal Strategy: Core earnings recovery needed to spur domestic economies
Back in the third quarter of 2013, Europe was trading favorably at a seven or eight price-to-earnings ratio, which made it quite attractive to many investors, said Eric Sagmeister, portfolio manager of the Forward Dividend Signal Strategy. However, “that was without any substantial earnings or GDP increases to back it up,” he said, “which meant that when earnings came through, it was clear that the rally would be limited.”
Now, with deflation a reality, many investors will expect to see quantitative easing happening shortly in Europe, and that could spark another rally. “But what we really need is for core earnings to recover on the domestic corporate side in Europe,” Sagmeister said. “This hasn’t happened in Europe and we have just been stuck at that point for some time.”
That is frustrating, he said, for investors who would want to be able to choose names beyond the European large cap and multinational companies, which have been better performers. However, “people do need to remember the great diversity of Europe and the fact that it’s not one central bank for one economy,” he said. “The ECB’s task is monumental and it has to deal with multiple economies.”
The current low value of the euro will help European exports a great deal: “A 10% euro depreciation is estimated to have a positive 5% impact on nominal exports and a 0.75% positive effect on nominal GDP, and with quantitative easing, it’s an even better cocktail,” Sagmeister said. He’s currently positioning his portfolio to take advantage of companies in, among others, the pharmaceutical and biotech sectors, technology and consumer durables sectors, all of which can benefit from exports into the U.S. and elsewhere, and he is also positioning himself carefully for the recovery in Europe’s domestic sector by pinpointing specific small- to mid-size names. However, for those opportunities to pan out, “we really do need a significant recovery in earnings to come in the middle of this year,” he said.
Quincy Krosby, Market Strategist, Prudential Financial: Dividend paying stocks attractive but macro situation must be addressed
For Quincy Krosby, market strategist at Prudential Financial, European valuations are still attractive and there are some very good dividend paying stocks that are well worth investing in.
However, with Greek elections around the corner and the left-wing Syriza party – which wants to renegotiate the terms of Greece’s bailout package — apparently a lead contender in the polls, Europe’s stability and the stability of the euro are Krosby’s greatest concern and the factors that will dictate investing in the region in the early part of this year.
“If the political situation worsens in Greece, there’s a chance that that starts to spill over to other countries, and I don’t think the markets have yet reflected that possibility,” she said. “There’s only a very small chance that Greece will leave the European Union, of course, but the specter of that has definitely risen again and highlighted the risk of other countries perhaps doing the same.”
Barring that possibility, though, the silver lining in the renewed tension surrounding the stability of the Eurozone is the likelihood that the ECB will come through quickly with some serious, U.S.-style quantitative easing, which Europe really needs.
“There are countries in Europe that have turned the corner but the key is to get them to gain traction,” Krosby said. “[ECB president] Mario Draghi has hinted that deflation is a real threat for Europe, but the question is whether any program will be enough to affect growth, to build up balance sheet strength. The market wants to see fiscal reform as well.”
John Maxwell, portfolio manager, Ivy International Core Equity Fund: Stick with European multinationals for now
Whereas the U.S. economy is now “flat lining,” Europe has room for greater improvement going forward, according to John Maxwell, portfolio manager of the Ivy International Core Equity Fund. With proper policy enactment and barring any major geopolitical tension or financial meltdown, this can bode particularly well for European multinationals.
“There are a lot of European multinationals that are head-to-head competitors with U.S. multinationals and our biggest exporters are European exporters,” Maxwell said. “We’re betting that ultimately, the European multinationals will have upward earnings estimates and the U.S. multinationals, just the opposite.”
Although Maxwell does own some domestic companies in Europe, he is still underweight those names and believes the greater opportunities lie on the multinational side.
Overall, Maxwell believes that Europe is still an “underbought” market and that adds to its appeal. In the past years, investors have wanted to be in more liquid markets, “but if Europe does a couple things right this year they could have a good year,” he said.
The low value of the euro will improve things for many European exporters, however, there’s no denying that the overall European picture is still unstable and “the greatest challenge to the region is the experiment that is the Eurozone,” Maxwell said.