Over the year, investors have continuously voiced similar fears about Europe and increasing exposure to the region in their portfolios. Nick Davis, fund manager, Polar Capital European Income Fund, looks at some of them and explains why investors should reconsider their positions.
QE is no magic wand
As Draghi has repeatedly warned the politicians, monetary policy cannot fix the medium-term challenges that Europe’s economies face. Structural reforms to improve competitiveness are the only ways to boost the medium-term outlook. In short, QE is no magic wand to the medium-term challenges of demographics, high debt levels and stagnating productivity.
However, it is also important not to dismiss the impact of QE in Europe. The collapse in lending rates to the real economy, and importantly the collapse in spreads between different Eurozone members, has been remarkable. The era of hard money and austerity while all other major regional economies did massive stimulus is over. At the very least, investors should be more upbeat on the region’s relative prospects in the next 18 months. Plenty of measures are now showing an improving outlook – house prices are rising, unemployment is falling and the bank lending surveys point to improving trends. Inflation remains low, although a big contributor to this is the fall in oil and that should be a tailwind for Europe.
The market is expensive
The market is certainly not optically cheap and the unwinding of the Euro crisis fear factor has seen the region re-rate in the past couple of years. However, in the context of a gradual improvement in earnings, investors will be rewarded for investing in the region as it continues to normalise. Conventional wisdom tells us to buy cyclical stocks when they look expensive because it means their earnings are low and likely on the verge of recovering. This likely applies to the European market today.
The dividend yields of high quality companies such as Nestle (yielding 3% in Swiss Francs and growing at least mid-single digit) looks very compelling relative to almost every other asset class. While these stocks may have optically high price earnings ratios, this fails to capture the improved strength of balance sheets, low volatility of earnings and long duration of growth of its brands. Solid compounding stocks are likely to get even more expensive in a low growth and low return world. In short, they continue to look competitive to us.
Swiss stocks are unattractive due to Swiss Franc worries
A depreciating Euro represents a headache for its neighbouring economies as it reduces their competitiveness. It is very important to analyse each company on its merits rather than writing off whole countries for currency reasons. A strong Swiss Franc is not a new challenge for companies based there. The important thing is to identify vulnerabilities in a business from a bottom up view – and a big currency mismatch between costs and sales (in any currency) should be a red flag.
Europe will see earnings gradually recover after several years of no growth. Low-risk equities with reasonable and growing dividends continue to look attractively valued relative to other asset classes. Investors should perhaps be more sceptical on the prospects for high yielding stocks with no growth and as they can be particularly vulnerable to uncertainty in the bond market.