09.24.2014
By Terry Flanagan

Fund Managers Bullish on Europe

Templeton Global Equity Group said more attractive valuations may lure investors back to European stocks, even in Russia, while Pimco expects opportunities from the asset purchase program from the European Central Bank.

Tucker Scott, portfolio manager at Templeton Global Equity Group, said in a report that the current tension between Russia and the West over Ukraine shows why investing in Russia has been considered risky but now may be a good time to invest in the country.

“With the Russian stock market trading at a discount to book value – it traded at 0.6 times book value early this year – we believe now may be a fair time to revisit investing in Russian equities,” he added.

In addition to the discount to book value, Scott said Russian stocks have paid high dividend yields in the last couple of years which makes stocks more attractive.

“From an investment standpoint – particularly in Russia – we think it’s important to look for companies that adhere to strict corporate governance practices,” Scott added. “We have found that in some cases, share prices of Russian companies have declined in value so far that much of the news regarding the Ukraine conflict was already discounted, and subsequent geopolitical developments haven’t created additional market aftershocks.”

Scott wrote that European equities in general are attractive compared to US stocks as the S&P 500 has a price-to-earnings ratio of almost 17 compared to 14 for the MSCI Europe Index.

“That doesn’t even begin to tell you how cheap Europe’s market is compared with the US market, because the ratio is using current profits, which have been very elevated in the US and depressed in Europe,” Scott added. “If we adjust earnings in terms of where we think they could be headed in the future, we think this gap between P/E ratios could widen even further.”

The Templeton manager said the firm is finding value in European banks and financial companies, particularly French bank stocks and insurance companies.

Scott said that from a macro perspective Europe is likely near the bottom of its profit cycle while the US is likely near the top.

Andrew Balls, deputy chief investment officer and head of European portfolio management at Pimco described opportunities from the European Central Bank’s asset purchase program in a report following the fund manager’s quarterly cyclical forum this month

On 4 September, the ECB said it will buy asset-backed securities and covered bonds in a quantitative easing program that is similar to the purchases of mortgage-backed securities by the US Federal Reserve.

Balls said this was the first step towards a broad-based asset purchase programme from the ECB as part of a full-blown QE program.

“It is likely that the ECB will not be able to buy very large quantities of ABS unless the technical challenges to banks securitising loans on their balance sheets can be sorted out, and/or the technical and political challenges to government guarantees for ABS for small and medium-sized enterprise loans can be addressed,” he added.

A QE program could have the the potential benefit of weakening the euro according to Balls while the ECB has also stressed the need for fiscal expansion and structural reforms to support medium-term growth.

Balls said: “The eurozone already has a mild form of Japanese-style stagnation. If political constraints continue to prevent the ECB from acting accordingly, then the risks of a full-blown and destabilising deflation will increase.”

Over the next 12 months Pimco favours being underweight eurozone duration.

“We prefer to earn carry by selling volatility in eurozone rates markets, based on fundamentals and relative value comparisons,” added Balls. “We expect the ECB’s actions to continue to repress volatility and a mild form of Japanification of the eurozone’s macro outcomes.”

In eurozone core countries Pimco expects to continue to be underweight the long end of the core curves. “The rich level of the eurozone long end reflects regulatory-driven demand on the part of pension funds and insurers; but on top of past changes, there is the potential for further liberalisation that could trigger shifts out of the expensive long forwards,” Balls said.

Pimco also expects to remain overweight peripheral sovereign risk by focusing on Spain and Italy, particularly as fundamentals improve in Spain.

“We expect to continue to look for opportunities in financials, notably senior debt in peripheral banks and bank capital more generally, and – given the ECB’s supportive stance – in ABS and covered bonds,” wrote Balls. “We expect these positions to perform well in the absence of a full-blown ECB QE, and even better if the ECB finally delivers. This also applies to being underweight the euro.”

Balls added that following Scotland’s decision to remain in the UK, Pimco remains broadly neutral on the British pound.

Featured image by leungchopa/Dollar Photo Club

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