European shares are a global value magnet
Europe is the destination de jour for global fund managers enthralled by the developed world’s fastest growth purchasing manager indices, the sharp fall in political risk after Macron gutted the National Front in the French election, a potential 15 per cent EPS growth momentum and the return of sustainable GDP growth. The IMF has upgraded its global growth forecast to 3.5 per cent in 2017, nirvana for the Old World’s global corporate empires. Dr Mario Draghi has ruled out any imminent ECB ‘taper’. The German export colossus is on a roll. Spanish GDP growth will be 2.7 per cent, the fastest in the EU, which itself could well deliver two per cent growth. Germany, France and Benelux, Carolingian Europe, benefits disproportionately from a revenue growth cycle due to their high operating leverage business models.
True, the European equities theme is not new. I have been flagging the virtues of Europe after having made several due diligence (yeah, right) visits to Munich, Garmisch, the Black Forest, the Cote d’ Azur, Madrid, Andalucia and Veneto in the past year. My recommendations to invest in Dutch banks ING and ABN Amro, Spanish bank BBVA, French banks BNP/SocGen and UK bank Barclays all returned 20-30 per cent, far above the Stoxx Euro 600’s 18 per cent return in the past 12 months.
After the US Dollar Index soared 25 per cent since mid-2014 while oil prices crashed from $115 to $28 Brent, it did not take a genius IQ to figure out that European financials would be a nobrainer as long as Berlin and the ECB did not upset the quant easing applecart. Now Trump wants King Dollar down (whoa boy!). Yellen wants shway-shway monetary ‘normalisation’. The Euro Stoxx 600 trades at 15.6 times earnings, a discount to the S&P 500’s 18 multiple. Despite Article 50, despite Macron’s En Marche’s need to win then National Assembly elections (the third round!), I still love European equities on any pullbacks on global markets.
True, Europe’s refugee crisis nightmare continues unabated, as do the civil wars in Ukraine, Syria and Iraq. The Old World is traumatised by the bloodiest and spectacular terrorist attack since the Red Brigades rampage of the 1970s. The horrific Manchester mass murder of teenagers and children only adds to the angst.
Unlike Wall Street’s money center banks, European banks did not recapitalise and amass ‘fortress balance sheets’. Europe’s currency union did not lead to a banking or fiscal union. Greece’s disputes with the IMF, EU and Berlin could yet erupt into another Club Med sovereign debt crisis as could the election of the anti-capitalist, anti-Euro Cinque Stelle (Five Star) movement in the next Italian election. Europe’s discount to Wall Street is both significant and not without macroeconomic logic, though European companies offer some of the highest dividend yields on Planet Income.
European equities have a 90 per cent correlation coefficient to the S&P 500 so any sharp hit in American equities will have an immediate impact on Europe. This could happen if Trump’s latest Comeygate (or Putingate) scandal escalates into a constitutional crisis or US earnings peak/disappoint in the second quarter. However, net earnings in Europe are a staggering 40 per cent below pre-2007 levels, so the runway to ‘profit normalisation’ is so long in the Old World that it is entirely possible that stock exchanges on both side of the Atlantic could ‘diverge’ in their performance, particularly if the euro tests and scales its May 2016 high of 1.16. The defeat of Marine Le Pen in the French elections has removed an immediate existential threat to the future of the Euro and the EU. The German election in September is less pivotal as the next Chancellor will either be Angela Merkel or the even more pro-euro, SDP candidate Martin Schultz. The real danger to European equities will be the Italian elections, which must be held before May 2018.
The most obvious sector trade to capitalise on Europe’s economic growth momentum and continued ECB policy accommodation is to buy French banks since Societe Generale and BNP Paribas both trade below 0.9 times book value and 11 times earnings. Europe’s Stoxx 600 index, up 18 per cent since last June, is no longer dirt cheap but I feel Swiss healthcare colossi Novartis and Roche Holdings are undervalued relative to their sheer excellence in research and thus earnings power. Europe’s consumer confidence surge will also benefit Unilever and Danone. A visit to Madrid and Seville earlier this year convinced me that Spain could well prove Europe’s Cinderella stock market, the reason I love Banco Santander, BBVA, the insurer Catalana Occidente and tourism’s Melia Hotels. The Melia Colon is the best hotel in all of Andalusia!