Finding Value in European Stocks

Financial stocks' fall in value, and changes in currency prices mean the European stocks look attractive for the long-term investor

Dan Kemp 30 August, 2016 | 12:01PM
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European stocks look attractively priced. This is a contrarian judgement supported by material drops in financials, pound sterling and the euro which combine well with supportive valuations.

HSBC are now claiming sterling could fall to parity with the euro

Continuing the contrarian bent, we see intriguing long-term opportunities forming in many unloved markets, including many of the emerging markets in Europe. For instance, there appears to be long-term opportunity in countries such as Greece, Russia, Turkey and the Czech Republic, all of which are well represented in the emerging market Europe index.

It should be noted that any investment is this space requires a thorough assessment of risk amid rising geopolitical constraints. Therefore, while it is a theme growing in attractiveness, the risk-adjusted returns may not be suitable for all risk profiles – and should only ever make up a very small part of a well-diversified portfolio. This illustrates an important point to remember: the areas of greatest opportunity tend to come with the greatest sense of discomfort.

Financial Stocks Look Attractive

At a sector level, European financials ex-Italy continue to gain in attractiveness on a long-term view, especially following the broad-based banking malaise post Brexit. However, this is not just a Brexit story, as financials in Japan are down 35% over one-year and US financials down around 1%. In Europe and the United States for example, financials appear to be one of the few sectors that have not excessively exceeded their fair-value estimate. Of course, value is only a part of the story and low interest rates will not help bank profitability in the medium-term.

With these considerations in mind, the key question becomes what to do. More specifically, what does this backdrop mean for dividends, earnings and valuations? The expected sector returns on a global scale continue to show significant variability. We see long-term opportunities in sectors such as financials and healthcare, whilst we retain a healthy amount of cynicism for over-heated sectors such as information technology and consumer discretionary stocks.

Sterling Drops in Value

In its current form, the pound sterling is a very difficult asset to judge. While a decline in sterling following the ‘leave’ vote in the Brexit referendum could have been anticipated, the lack of support thereafter has been more surprising. Over recent weeks, investments denominated in GBP will be very pleased to see strong returns, however these can’t be guaranteed going forward.

It is worth making the point here that while sentiment is likely to dominate in the short term, sterling appears cheap and is therefore likely to rise in value over the longer term. One remarkable point is the amount of attention from the wider public. Maybe it is the political theatrics, or maybe it is the time of year, however the amount of public interest in the pound sterling has hit a record high.

In fact, the pound sterling continues to see gradual weakness amid the economic uncertainty and one cannot be sure how deep this contraction could go. Even HSBC are now claiming it could fall to parity with the euro, although we warn that history provides no basis for these types of claims.

Regardless of the short-term direction, the recent pound sterling and euro weakness are likely to be possible benefactors to these economies. We will be keeping a close eye on a number of key economic metrics to help guide our view; including manufacturing surveys, central bank activity, inflation readings, property prices and household consumption to name just a few.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Dan Kemp

Dan Kemp  is Chief Investment Officer, Morningstar Investment Management EMEA