Don’t write off Europe, says Invesco’s Butcher

Stephanie Butcher, European Equities Fund Manager at Invesco Perpetual, provides her outlook on the European market.

There is no great love in investors’ minds for Europe. However, we believe Europe will prove itself to investors again.

Last year Europe faced existential currency and political risks, endless emergency summits, policy volte faces, and a general sense of teetering on the edge of an abyss.

Since the low on June 1st last year, the MSCI Europe ex-UK index is up 43% in sterling terms. Yet the general feeling of mistrust lingers.

Draghi’s ECB is possibly the only European institution with market credibility. The market rally has climbed a wall of worry including the left-field results of the Italian election, and the farce that was the Cypriot bail-out. But climb it did. What is required to see markets climb further?

The good news is that we don’t need to love Europe in order to invest in it.
At current levels valuations are so cheap on a cyclically adjusted basis that I believe the environment simply needs to be ‘less bad’ for Europe to be an attractive case. We could point out that Europe is chock-full of world class companies, which have international exposure, and are (thankfully) run by first-class managers not politicians, but that has been the case for a while and it hasn’t persuaded investors thus far.

As investors we have one role – that is, to find under-valued assets, whatever those assets might be. Most appear to be persuaded that bonds are intrinsically over-valued. Equally, many seem persuaded that equities are, at this point, a cheap asset class.

What fewer seem to accept is the fact that Europe today is the global value play, and within Europe itself, there are areas of the market which sit at generationally low valuation levels.

On price/earnings adjusted on a 10-year through-cycle basis, Pan-Europe is 25% cheap, Economic Monetary Union block is 37% cheap, but Italy and Spain are currently sitting in the range of 50-60% below their long-term average Shiller PEs2. So, after 5 or so years of economic trauma, with car sales, TV advertising, and property markets falling in some cases 50% plus, these markets are trading at trough multiples on trough earnings.

At Invesco Perpetual we are pragmatic and open-minded as to the sources of sustainable dividend income across Europe. Valuation, yield and dividend growth opportunities in Europe are in our view attractive, but not necessarily in the ‘traditional’ income sector. Where we currently see most potential is financials, the periphery and selected cyclicals where dividend revisions are improving, and valuations and pay-out ratios are low.

Crucially, expectations in some of the cheapest areas of the market are modest if not outright pessimistic. Positive momentum comes in two ways; good things getting better, and bad things getting less bad.
Ultimately we believe Europe will prove itself to be loveable again.

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