New York: Some very big investors are betting on an upswing in two problematic parts of the world right now, Europe and Japan, their confidence bolstered by the brisk money-printing from central banks in both regions.
Standard Life Investments, Goldman Sachs Asset Management, and Seven Investment Management are among those who believe in the potential returns to be found in European and Japanese stocks. Depreciating currencies, compelling valuations and rich dividend yields are among the biggest attractions. European banks, for instance, haven’t looked this cheap since the 1980s, investment managers said.
Worries about economic weakness in the two regions helped trigger big stock market drops in the past two weeks. But rather than run for cover, several viewed that as a chance to scoop up shares at lower prices, arguing that a solid outlook for corporate profit growth was being overlooked in the economic gloom.
“This is our kind of market,” said Marc Halperin, portfolio manager at Federated Investors in New York, with assets under management of $352 billion. “When there’s blood in the streets and there is a high level of panic, uncertainty and irrationality, this is when we do the best.”
The firm’s $1.6 billion Federated International Leaders Fund, which Halperin helps manage, currently has about 75 per cent of its portfolio invested in European stocks.
John Maxwell at Ivy Funds in Kansas City said he added to holdings in four European companies and created new stakes in two others following the selloff in European stocks last week. Maxwell’s $2.6 billion Ivy International Core Equity Fund has about 45.2 per cent of the portfolio invested in Europe.
A significant allure is that European and Japanese stocks are simply cheaper than most US shares.
On a price-to-book value basis – a measure of a company’s worth should it liquidate – European stocks are at a 34 per cent discount to those in the US, Barclays data show.
Meanwhile, Japanese corporate earnings have beaten consensus estimates for seven straight quarters, but the market’s forward price-earnings ratio is stuck at the low end of its historical range. Japan’s PE multiple is 15.5, compared with 17.2 in Europe and 18.7 in the United States, Morgan Stanley data show.
Diverging policies, other risks
To be sure, it’s not a riskless bet. The International Monetary Fund recently doubled its probability for a eurozone recession to nearly 40 per cent, and the simmering standoff between Ukraine and Russia, the region’s biggest gas supplier, means there is the possibility of energy disruptions in the coming winter months.
Another worry is diverging monetary policy paths as the US Federal Reserve pivots slowly toward interest rate hikes, while the European Central Bank and Bank of Japan keep the easy money flowing. Those bullish on European and Japanese stocks say plans by their central banks to keep pumping money into their markets should provide ample cushion.
“We don’t share the view that (US) rate rises are going to be destabilizing,” said Chris Darbyshire, chief investment officer at Seven Investment Management in London, which manages $10 billion in assets.
Seven Investment reduced European holdings in the middle of the third quarter, but recently reinstated exposure in the region’s banking sector, Darbyshire said, citing the ECB’s stimulus, which includes buying banks’ asset-backed securities and covered bonds.
“Not only are valuations better, but dividend yields have improved materially,” said Darbyshire. “The European market is yielding close to 4 per cent. That’s not a bad return, even if markets go nowhere.”
Despite the sell-off, including a destabilizing plunge in stocks globally on October 15, global equity inflows into Europe have still been positive. Investors have poured $11.2 billion into European stock funds so far this year, through October 21, compared with $29.4 billion in the same period last year, data from EPFR Global show, though they suffered big outflows in the latest third quarter.
A weak euro has further boosted the earnings outlook for euro zone exporters by making them more competitive on world markets, as well as boosting profits from overseas operations once they are translated into euros. This has prompted Barclays Capital to forecast higher European corporate earnings for 2014 and 2015 at 10 percent and 17 per cent, respectively.
Goldman sees opportunities in European equities.
“We need to remind ourselves that in buying European equities, we’re not buying the European economy, we’re buying European corporates,” said London-based Neill Nuttall, co-chief investment officer of global portfolio solutions at Goldman, which oversees $1.14 trillion in assets.
Goldman’s US rival Morgan Stanley is forecasting a 12-month return of 13 per cent for the MSCI European index, compared with just 8 per cent for the S&P 500.
And Seven Investment’s Darbyshire said European banks’ price-to-book ratio is currently around 1.0, a low level not seen since the mid-1980s.
“European banks are a screaming buy as it’s one of the cheapest sectors,” said Roger Sadewsky, investment director at Standard Life Investments in Edinburgh with about $337 billion in assets. “If you can take a longer-term view … European banks should have some upside over time.”
A weakening yen is also drawing attention to Japan, where the TOPIX index gained 5 per cent in the third quarter compared with just 0.6 per cent for both the S&P 500 and the European index.
Global equity flows still show inflows into Japan, totaling $14.1 billion this year, through to Oct. 21, compared with $41.1 billion in the same period in 2013, EPFR data show.
Morgan Stanley estimates a 12-month return on the TOPIX of 18 per cent, noting Japanese equities could outperform again once Japanese investors start buying their own stocks.
Japanese holdings of domestic equities remain near all-time lows. Barclays said a conservative shift toward the middle of the 20-year range of Japan’s holdings of stocks would translate into more than $1 trillion in flows into Japanese equities from cash or the government bond market.
Seven Investment has a triple overweight rating on Japanese stocks.
“There are dozens and dozens of catalysts in Japan and any one of those on their own would be a big deal for another country,” said Seven Investment’s Darbyshire. One big plus for Japan is the fact that both the government and the Bank of Japan are on the same page in terms of stimulating the economy, a dynamic not at play in Europe or the United States.
“Has the case for equities changed on a one-day basis? No, not at all,” said Standard’s Sadewsky. “In fact, last week’s sell-off has created terrific opportunities for us.”