I recently spoke with Luke Stellini, European Product Director at Invesco Perpetual, and asked him about his take on the macro environment, where investors in Europe can find value at the moment and which European equities are looking particularly attractive.
Cook: Concerns about the economic recovery, particularly in the United States, have weighed on equity performances on both sides of the Atlantic of late. What’s your take on the macro environment and how do you see this impacting investors in Europe?
Stellini: The way we look at things is to weigh up headwinds and tailwinds and it’s been very much a headwind camp in terms of equity market performance over the last two to three months. And I think that’s probably best exemplified by the different reactions that equity markets have had versus bond markets: you’ve had quite a significant decoupling between the two, mainly as a result of different markets’ interpretations of exactly the sort of data you’re referring to—things like US ISM surveys and employment data—proving to be a bit sticky to the downside.
I would say that right now markets are generally a little too obsessed with weekly announcements from a data point of view. Since probably the middle of August, we’ve actually seen a small improvement in some of the main data points, so, for instance, the main ISM survey in the US definitely positively surprised, as did some of the private sector payrolls numbers, and those are the two areas that I think we’re most closely watching. It’s difficult to call them a trend as yet but I would say that right now the environment is probably more supportive than it was even four or five weeks ago.
From here, the key thing as far as we’re concerned, in terms of sustainability of a recovery point, would be watching the employment data in particular, together with that ISM, to get an idea of what the sustainability of top-line growth is going to look like on a 12-, 18- and 24-month view. Right now it’s very difficult to call that but the most recent data has been supportive.
Cook: You mentioned the decoupling of equities versus bonds. Some fund managers I’ve spoken to recently have talked about a disconnect between equity performance and economic performances, particularly in the UK, whereby economic performance is very much subdued but that doesn’t mean that equity performance has to follow the same trend going forwards and there’s actually an opportunity for equity performances to far outstrip that of the economy. Is this a view you share?
Stellini: I suppose it’s a question of what you think markets are discounting currently and where you think valuations are as a starting point. Our central case is that valuations on European equity markets are just very, very cheap and discount a pretty negative outlook from here. So any sense of stabilisation, or even recovery—our central case is for a fairly anaemic recovery but a recovery none the less, would imply to us that current valuations are cheap. We’re looking at valuations in a whole variety of ways, from straight P/Es, to P/Es using long-run average earnings, to comparisons between dividend yields and government bond yields, or dividend yields and credit yields. In fact, I think one of the more interesting metrics is equity participation levels being so depressed—if you look at measures of participation from eurozone financial institutions’ point of view, then the asset class looks very out of favour. Our view is that from a starting point this is a very positive place to be for equities.
Cook: Given that you see equities as particularly attractive at the moment, are there any areas within European where you see more value?
Stellini: We’re pretty bottom up in our views, so our analysis is very much done on a stock by stock basis. From a slightly more top-down view, we wrote a piece recently about the Dutch market that wasn’t necessarily saying that we think the Dutch equity market is cheap per se but that it’s an open market, with very diverse sector representation, and high quality business within that, and many of those on their own merits look to us to be cheap.
If we were going to pinpoint another area, I think one of the things we took advantage of in April/May time were some of the valuations that came about in peripheral Europe. High quality international businesses in the likes of Spain, which got hit very, very hard in a market that failed to differentiate between budgetary constraints in Spain versus, say, Greece, and then saw a large, multinational Spanish bank as the best way of shorting that country. That sort of volatility created extremely good valuation opportunities in the market overall but also specifically within one or two large international businesses.
The other sector I would flag up from a top-down point of view would be healthcare. We continue to feel that pharmaceuticals are exceptionally cheap for the quality of the businesses that you’re getting there. So that’s one sector that I think we can fairly happily attach a label of “attractive valuation” to.
Cook: Within healthcare, obviously there are the large-cap names but there’s also been some M&A activity in the biotech area, for example, such as Crucell recently. Across the market capitalisation spectrum do you see some differentiation in valuations between, say, smaller caps compared to large-caps?
Stellini: Not really. I think actually if you end up in the mega-cap part of the market that’s probably where, in terms of headline multiples, you’ll find a lot of good value.
I think that from an M&A point of view, we’re starting to see this return as a theme. As far as we’re concerned basically all the conditions are in place for M&A bar the appetite for it. There’s still trepidation about market volatility but I think you’re seeing that starting to reduce. For instance we had Safran, a French aerospace business, talking about making a billion-dollar US acquisition earlier this week, commentary that we’ve had out of EADS is supportive of M&A, we’ve obviously had a fair amount of it in the UK, and you mentioned some of the biotech stuff, so I think that’s all indicative of valuations being cheap. We’re now keenly looking at management to give us a lead on their own measures of confidence, because if they’re pushing the button on doing deals then it must imply that their confidence on the outlook is improving.
Cook: Clearly you’re quite optimistic about valuations in certain areas within Europe. For the individual investor—the man on the street reading the newspapers—it’s all looking rather glum at the moment but speaking to you, just as I’ve spoken to fund managers and other investment specialists, it seems that the view from within the industry is actually far more optimistic. Do you think that’s a fair assessment?
Stellini: I think the man on the street probably doesn’t do a lot of valuation analysis, and that’s probably the difference. If you’re at the coal face and you see the sort of valuations that we and other market participants are seeing then it’s difficult not to come to the conclusion that a lot of the noise people on the street hear is already discounted in share prices.
Our key mantra on this is you have to do the work and you have to do the bottom up analysis on each individual company to come to a conclusion. I don’t think it’s a blanket thing that you can say “everything is cheap” because that’s not the case, but there are some very, very good opportunities out there.
