25th November 2010
For Rory Bateman, head of European equities at Schroders, leaving aside problems of the peripherals like Ireland, Greece and Portugal, the macroeconomic environment across the region continue to provide signs of encouragement, with economic activity remaining supportive.
Latest indicators reveal industrial producer prices rose 0.3% in the euro area from August to September, while new industrial orders increased by 5.3% from July to August.
Most recently, the German and French economies have shown economic growth of 0.7% and 0.3% respectively in the third quarter.
And only yesterday, as reported here by Bloomberg, it emerged that German business confidence unexpectedly surged to a record high in November as domestic spending increased, bolstering the economic outlook.
The Daily Telegraph also reports on the promising German confidence numbers, saying that the country's "boom" ought to lead to a much-needed rebalancing of trade and capital flows in the eurozone, but that it will not mean that the single currency's existential crisis will go away.
Employment trends across Europe, with the exception of Portugal and Greece, have also started to improve. For instance, October official labour office figures revealed that unemployment in Germany had fallen to levels not seen in 18 years.
Germany in particular has outperformed on the labour front thanks to the adoption of flexible working conditions.
"Since reunification, there have been dramatic productivity improvements in Germany, and we believe this could support a stronger consumer environment and drive growth in consumer expenditure going forwards," says Bateman.
Consumer confidence across the euro area also looks to be stabilising though Bateman stresses there is a geographical divergence, effectively a north/south divide: consumer confidence in Germany and Sweden for instance is robust while in peripheral countries, such as Spain and Italy, it remains weak.
Certainly the weaker euro has contributed to the strength of the macro data in core Europe with export-orientated businesses benefiting from the currency depreciation.
As Reuters reports here, the euro is struggling at near two-month low as the eurozone debt crisis showed little signs of abating and fears of contagion still high after Ireland unveiled an ambitious austerity plan.
Bateman notes that although the single currency has actually strengthened since the lows seen in June, current rates are still falling shy of the longer-term average of $1.40 for the euro/dollar rate.
European exporters, therefore, remain better positioned than they were certainly a year ago – especially as there has been a recovery in global demand.
Meanwhile company earnings over the last 12 months have been "robust", says Bateman, adding: "We believe there is room for double-digit earnings growth in 2011, with figures still sitting below trend.
"If we consider the amount of cost-cutting that European companies have had to embark on over the last few years, many are now very lean businesses relative to history.
"As a result, we feel these companies are in a strong position – backed by a resilient economy – as we go through into 2011."
Additional support is being provided by very strong corporate cashflows, with company balance sheets looking "particularly robust", with Bateman noting: "The debt-to-equity ratio for European companies right now is at 50% and is forecast to reach 20-year lows over the coming quarters."
With these factors in place, Bateman expect an uptick in M&A activity and increasing cash returns to shareholders through dividends or buybacks. Nestlé is an example of an European company that is already demonstrating this trend, he says.
As for the fundamentals, relative to historical data, European equities are still trading on very appealing multiples. "If we take the one-year forward price-to-earnings (PE) multiple, there is some way to go before getting back to the average trend line over the last 20 or so years.
"This also applies if using 10-year average earnings which tries to strip out the volatility of the earnings.
So, both on short-term and long-term multiples, Batemans feels that the absolute valuations continue to look very attractive. There is good news also in relation to other regional equity markets, with European equities trading on lower multiples than US or Asian equities.
"Clearly, faster growth in Asia accounts for the gap here, so a premium is to be expected. However, we think this gap is still too wide, as is the gap versus developed markets, especially the US.
"Europe is definitely providing opportunities to purchase stocks at relatively attractive prices, and there is certainly room for further re-ratings in the market."
More broadly, Bateman does not expect a double-dip scenario to develop to undermine the generally positive prospects for core Europe.
While the euroland peripherals will likely continue to face substantial difficulties, Bateman is confident that core Europe is on a "stable road to recovery", having been relatively underexposed to excess leverage.
Furthermore, in 2011, he expects companies across core Europe to reinvest in their businesses and return excess cash to shareholders.
Bateman concludes: "European equity market valuations remain attractive relative to other asset classes, where in some cases we see asset bubbles developing, driven by ‘safe haven' status and temporary global quantitative easing. In addition, European equities are also attractively valued against the US and emerging markets."
Bateman's views on the impact of the peripherals on European equities is echoed by Luke Stellini, European equities product director, Invesco Perpetual, in an IFAonline article. He says that a successful Irish bailout, for instance, is important but not critical to the outlook for European equities.
In the same article, however, Daniel Pasini, head of equities, ACPI Investments says the importance of a successful Irish bailout for euro denominated assets, including equities, cannot be underestimated.