But subdued risk appetite can’t deter investors from European equities now. According to Bank of America-Merrill Lynch’s September Fund Managers’ Survey, two thirds of investors view them as cheap, the highest reading since February 2003. “This offers scope for a rally should economic news improve,” says Gary Baker, head of European equities strategy at BofA Merrill Lynch Research.
Deutsche Bank analysts Michael Biggs, Gareth Evans and Joelle Anamootoo agree: “The valuation case for equities appears persuasive, but invariably the market needs a trigger for the favourable valuation case to translate into equity performance.” They reckon that the fair-value forward price-to-earning (p/e) ratio for European equities is 12.5 times, some 16 per cent above the current forward p/e of 10.8 times. Their research also suggests that a 1 per cent upside surprise in GDP growth raises equity returns by 6.95 per cent, so any growth improvements will be good for equities.
Although there are signs of a moderation in the pace of growth in the second half of the year, the European Commission (EC) now expects that the Eurozone economy will grow this year at nearly twice the pace that it forecast in the spring. And the prospects for the second half, despite the slowdown, now appear rosier than the EC anticipated back in May.
One fund manager who has been consistently bullish on European equities since the start of this year is Alister Hibbert, manager of BlackRock’s European Dynamic Fund. “Europe offers some of the best businesses at low valuations, benefiting from exposure to the most attractive trends within emerging markets. Emerging markets account for around 20 per cent of European corporate revenues across the market,” Hibbert says.
His picks include Finnish winter tyre manufacturer Nokian Tyres, which is forecast to
benefit from economic recovery in Russia and a more powerful Russian consumer. Winter tyres command more brand loyalty than normal tyres, so the returns are much higher – it generates a 30 per cent-plus operating profit margin within its tyre division in a normal year.
Also in the European Dynamic Fund is Denmark’s Novo Nordisk, which is a fast-growing pharmaceutical firm that is the dominant global franchise in diabetes treatment and has a 60 per cent share in the Chinese insulin market. As China gets wealthier, it is also expected to step up government spending on healthcare. Novo Nordisk has experienced an 850 per cent relative return to the FTSE World Europe ex UK over the past 15 years but Hibbert does not think that it is expensive given that the cautious management thinks the business can grow 15 to 20 per cent per year.
Investors are slowly coming round to the idea that European equities are undeservedly unloved – it is just a case of picking the stocks to capitalise on the most attractive opportunities.