The European Union is the world’s largest economy. Germany remains the world’s biggest exporter, and the world’s biggest food company Nestlé, mobile phone company Nokia, steel company ArcelorMittal and construction firm Vinci are all European.
The most lucrative investment opportunities often start with nothing but a compelling valuation, only developing the exciting story at a higher price. Europe is currently the cheapest equity market in the world – cheaper than the UK and the US, and much cheaper than emerging markets, which now trade at premiums to developed markets despite historical higher risk.
The key to successful investing is buying when stocks are cheap and selling when they are expensive. This has always been true, despite people’s tendency to only buy things that have already gone up.
European markets traditionally have higher beta than other developed markets. When economic growth is recovering and equity markets are rallying, European markets tend to go up more than other developed markets.
Investors have tended to react too late, only buying into Europe at the end of a bull market. But there is now a great opportunity to buy into continental Europe while it is cheap and well-positioned to benefit from a US recovery which is expected to lead markets higher.
Argonaut anticipates that as the US leads a global economic recovery, the dollar – already undervalued on a purchasing power parity basis – will become much stronger, reducing the appeal of both emerging markets and commodities.
A strong dollar is, however, a positive for many European exporters who have fought the headwind of a strengthening currency for a decade, including world-leading consumer goods companies like BMW, Daimler, LVMH, Electrolux and Nokia.
Investors looking to play the economic recovery through commodities or emerging markets should reconsider. Those trades rely on the US maintaining a zero interest policy well past the point of certain economic recovery. They also assume that, despite a decade-long boom and supply responses, there is still under-utilisation in Chinese manufacturing and supply shortage in global mining, shipping and steel industries. The Chinese and commodity “secular” growth stories will also eventually prove cyclical, like many previous stories.
European interest rates are likely to stay low for a considerable period of time, but stockmarkets trade at multi-decade lows on almost every valuation metric.
Valuations have not been this cheap since the early 1980s or mid-1970s when interest rates and government bond yields were much higher.
Why accept a return of 1 per cent on cash when the average company, with considerable recovery potential, yields more than 4 per cent and there are plenty of low-risk companies in sectors like telecoms yielding around 7 per cent? The severe global recession and credit crunch may have offered a once-in-a-generation investment opportunity.
Of course, markets may have rallied more than 30 per cent from lows seen in March, but that only takes them back to where they started the year and puts them at the same level as 10 years ago.
While it has been a “lost decade” for investment returns, European companies have made real progress, increasing sales and profits by 95 per cent and 65 per cent respectively.
If value and contrarianism count for anything, now is the time to reconsider investing in continental Europe.
Barry Norris is a partner in Argonaut Capital