Carmignac: European Stocks Will Rally in 2017

Valuations of European stocks compared to UK and US equities look compelling, says Carmignac's Mark Denham, plus elections provide buying opportunities

Emma Wall 24 January, 2017 | 4:45PM
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Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today in Paris by Mark Denham Carmignac's Head of the European Equities.

Hi, Mark.

Mark Denham: Hi.

Wall: So, we'd be hearing this morning from your European Conference here in Paris and unlike some of your peers you are bullish on European equities for 2017. What's made you so happy?

Denham: Well, we think the environment for European stocks at the start of this year is very supportive. We're seeing increasing economic and earnings momentum in the form of leading indicators across the continent in various countries as well as for the first time in Europe quite optimistic expectations for earnings growth in 2017 of about 11% to 12% and that's widely spread across many sectors in the market. So, the momentum factor, which we think is a dominant factor, is supportive.

I think when you turn to valuation, it's a slightly mixed picture. On the one hand, the P/E rating of the market is about 15 times, 14 to 15 times, which is towards the upper end of its historic range. But then against that the dividend yield in the market is still getting 3.5% to 4%, which is attractive in a what's still a low interest rate environment.

Wall: Well, the elephant in the room, or I suppose the three elephants in the room are the European elections this year. We saw in 2016 how elections can go or referendums can go the way that perhaps the pollsters don't expect. One of the reasons why some of your peers are a little cautious on Europe is because of these key events. But you don't think that they are a problem?

Denham: I think – I mean, as you say, we have the Dutch elections in March, French elections in April and then German elections in Q3. I suspect that the upshot will be that it will cause a lot of volatility in stocks which will be an opportunity to add because this background theme of improving economic momentum is the dominant one.

You're right. We've learned from 2016 not to be complacent about the outcome of elections. But nonetheless, it looks likely, for instance, in the French elections that Marine Le Pen would not win against Mr. Fillon in the second round. And similarly, although the Freedom Party has the highest percentage of the vote in Holland, it's unlikely they will be able to form a coalition government under the Dutch system and in any event, it will take many months to form a Dutch government. So, I think, we're going to see a lot of news flow and commentary around the elections, but I think I would use those as opportunities to add to positions that we like.

Wall: As you said, valuations are a bit choppy across the board, but presumably there are opportunities in particular sectors or particular stocks where you are seeing more compelling interest?

Denham: Against the background I've outlined we definitely want to keep exposure within our funds to stocks that have sensitivity to the economy. But because we've seen such aggressive sector rotation already in 2016, we feel a lot of the economically-sensitive sectors that you would normally turn to have performed quite well already. All through 2016 the industrial sector, for instance, traded very well and is now trading at a market premium of about 17 to 18 times and we think that that adequately reflects what's likely to be an improvement in earnings there, but doesn't really make it attractive.

We think in some of the more consumer areas, like media, for instance, where we like WPP, the advertising agency or Business Services, so these are companies that service companies, offices with their electrical facilities or inspection and testing companies, so business like SPIE in France or Applus in Spain. These are attractive businesses exposed to the economic activity in Europe with strong cash flows and they use that cash flow to augment growth when growth has been weak. But as I say, we would expect growth to accelerate for those businesses.

Wall: And just to finish then that controversial sector you didn't mention, financials, how do you feel about European financials?

Denham: Yes. So, financials in Europe are economically sensitive. That said, they've had such a strong run over the past four months or so that on our assessment of them most of the stocks trade at around about one times price-to-book when they're likely to generate return on equities of only 6% to 7% which looks like it's already – the sector is already discussing an improvement in our profitability level.

But then I have to offset that against the fact that from a top-down point of view, while interest rates are rising and inflation expectations are rising even in Europe, the sector is likely to hold up quite well. So, we have some exposure, but I'm not looking to increase it now.

Wall: Mark, thank you very much.

Denham: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Emma Wall  is former Senior International Editor for Morningstar

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