Tawhid Ali, manager of AB European Equity Portfolio, explains why European investors should turn off their Twitter feed and focus on company fundamentals.
By concentrating on companies that are less exposed to regional instability, we think investors can discover resilient sources of return potential and avoid being held hostage to political headwinds.
Investors have reason to feel anxious as political uncertainty continues to spread across Europe. Equity markets look vulnerable to a range of issues from a possible renewal of the Greek debt crisis to Brexit and the populist challenge in elections in several major countries. We have recently seen many twists and turns in French politics and we’ve learned that attempting to predict political outcomes is nearly impossible.
Political risk cannot be ignored. But not every stock is affected in the same way. When scouting for European companies, investors would do well to sift out the political noise by focusing on these three angles:
1. Positive market dynamics: Look for companies that are well positioned to benefit from positive trends in specific markets around the world
2. Global leaders: Seek out European companies that are global players in their fields
3. Corporate transformation: Search for companies that are helping themselves and boosting cash flows through improved operational performance, corporate restructuring and changes to inefficient capital structures
Many European companies that score high in these areas actually have shares that trade at a discount. In part, this is because of the unsettled regional landscape, which is creating a compelling value opportunity, in our view.
European sector valuations are attractive
At the end of January, the MSCI Europe Index traded at a price/forward earnings ratio of 15x—an 8% discount to global developed stocks and a 14% discount to US stocks.
High-beta stocks, which are generally considered riskier, trade at very deep price/book discounts versus low-beta stocks. In other words, many investors are still overpaying for perceived safety, creating plentiful mispricing for stock-pickers to exploit, often in areas of the market with sensitivity to the global economic cycle.
Positive trends in Europe
Today, European stock markets offer abundant opportunities for investors who are willing to focus on company fundamentals rather than being distracted by political noise. Take stocks in the European chemicals and energy industries, for example, which are attractively valued against global peers and their own history.
In chemicals, some European players are well positioned to benefit from improving global supply and demand dynamics for specific products such as polyethelynes, used in plastics. Take Arkema, the leading international specialty chemicals company headquartered in France.
The company produces technical polymers and is benefiting from growing demand as auto manufacturers accelerate their efforts to make vehicles lighter. Trends like these should be resilient to the broader European economy.
Similarly, select European commodities groups might benefit as rebalancing supply and demand fuels price increases for products such as zinc sooner than expected. Zinc demand already outstrips mine supply with inventories being drawn to bridge the gap.
Assuming modest demand growth, the world needs new mines to be built and yet there are very few firm projects. Boliden, the Swedish-based mining and smelting company, is a clear winner from zinc market dynamics, in our view.
In the energy sector, some oil majors are still attractively valued, even after the 2016 rally. Companies that cut costs dramatically during the oil-price slump should enjoy more profitable business in the coming years. Royal Dutch Shell is a good example of the corporate transformation trend in play in Europe.
Management have confirmed their goals on cost savings, disposals and focus on shareholder returns over capex growth. Recent earnings reports confirm that the company should be able to continue to pay its dividend to investors, even at current oil prices.
And don’t completely ignore domestic industries; select consumer companies have global brands and European exposure, which could do well if consumer spending continues to pick up.
The potential for a highly market-disruptive event in Europe —such as a withdrawal of Italy and Greece from the euro—cannot be ruled out and investors should be vigilant about volatility. But investors can defuse this short-term political risk by focusing on select companies that are not at the mercy of unpredictable political events.