Europe still a great value opportunity, says Invesco’s Butcher

Stephanie Butcher, European Equities fund manager at Invesco Perpetual, joins a Q&A on European equity markets.

How have European equity markets performed recently?
The European equity markets have done very well recently – really over the last year or so – and I think that is a result of extremely low valuations as a result of the sovereign debt crisis, which has obviously been a major factor in people’s minds. It is a function of a supportive policy response from the ECB, and also evidence that economic data is beginning to recover. That is now being reflected in equities performing very well.

Are corporate earnings supportive?
Earnings levels are obviously quite depressed in Europe. As I say, that is a function of weak economic growth, the sovereign debt crisis and weak global growth, to be honest. At this point, there is a sense that in many sectors the lows have been reached. We are beginning to see evidence of earnings revisions to the upside, particularly in some of the most low-valued sectors – for instance, financials, some areas of cyclicality. That is proving quite supportive to equity market performance.What is the macroeconomic backdrop for Europe?

The macro environment in Europe is clearly not strong. We certainly would not argue that you are going to see any sort of V-shaped economic recovery. I think the major point to make is that at these current valuations things only need to be less bad, and, actually, you can see very strong equity performance. That is beginning to be what we are seeing, particularly in some of the periphery markets. For example, in Spain, we have seen evidence of GDP coming in a little stronger than expected and unemployment being a little less bad than expected. Now, that is being reflected in the fact that people are just beginning to put a slightly higher valuation on some of these equities, which were very, very beaten up at the lows.

How is your portfolio – the Invesco Perpetual European Equity Income Fund – currently positioned?

I think, in terms of positioning, it is a good time to be looking at European equities, because there are a number of areas that look very attractive at this point. At the sectoral level, for us, the most interesting area is financials, and, increasingly, within that, the banks. Capital ratios have been rebuilt quite aggressively, and in a number of cases we are seeing excess capital being built, and that allows some of these banks to start looking at dividend payments, which, as an income fund, becomes very interesting for us. At the country level, for us, some of the greatest opportunities are in the peripheral markets – particularly Spain right now. Spain offers a combination of very low valuations, very well managed international companies and structural reform at the government level. That combination sets up the potential for some really quite strong performance over the next few months, and going into the next years.

What areas are you avoiding?

I think, for us, in terms of what we do not like, valuation is always the key driver of what we do, both in terms of what we like and what we do not like. The areas where we feel valuations are getting quite stretched in Europe are the areas where people flocked for safety last year because of the sovereign debt crisis. In particular, they are areas like foods, beverages, HPC – some of the consumer staples and some of the global growth stories as well, the ones that were exposed to emerging markets – China in particular. They are not bad companies; in many cases, they are excellent companies. But we feel that the valuations attached to them, particularly in Europe, have become quite extreme, and we can get much better opportunities elsewhere in the market.

Have there been any significant changes to the portfolio?

We have not made major changes for a while in the portfolio, to be honest, because we felt that valuations got so extended – both to the downside, in areas which we like, and to the upside, in areas we do not like – in the middle of last year, 2012. That is now beginning to change, and we are seeing performance develop. Some of these unloved areas are beginning to re-rate. On the other side, some of the areas that we do not favour are beginning to trade sideways, if you like. We do not yet feel that the valuations have closed, to the point to which we want to change positioning. But, obviously, valuation is everything, and if we felt that had moved to an extreme we might look to alter the positioning of the portfolio.

Where are the dividend opportunities?

The good news, in terms of dividends in Europe, is that you can find very high dividends across the market. I think Europe generally offers some of the highest dividend yields globally. Within that, we find a range of areas where there are very interesting areas for dividends. On the more defensive areas, we still find pharmaceuticals very attractive – the likes of Novartis and Roche. On the more financial areas, we think some of the higher-quality banks – companies like Nordea, UBS and BNP. Insurers, as well – companies like Ageas. We think potentially areas like ING, over the next couple of years, are going to be very strong dividend growers. Then there are also areas of cyclicality: media companies like RTL, infrastructure companies like Atlantia – a whole range of companies. The one area in which we do not particularly find strong dividend opportunities is, again, these over-valued staples areas, where there are sub-market yields, and you pay a lot for them.

What are the key drivers of recent strong performance?

In terms of what has worked for the fund, I think it has been principally financials that have been big attributors to the fund, a number of the Spanish companies and also some of the other peripheral names as well – Fondiaria-Sai in Italy. I think it is just a function of the valuations. In the middle of 2012, a number of these areas were very, very unloved, and that often creates great opportunities. We spent a lot of time meeting companies, politicians, economists and central bankers to get a sense that the macro environment was going to remain supportive over the long term. Then we could focus on valuations, and those valuations were really pointing to those areas I mentioned. That performance has come through quite well over the last 12 months.

What is your outlook?

In terms of the outlook for Europe, we are still very positive. If you look at valuations on a long-term basis, Europe still looks like one of the great value opportunities globally. You have got the highest dividend yields, you have got depressed earnings and multiples are still not extended. Within that, you have got a number of sectors and countries that are still even more undervalued than that. So we remain very positive on Europe. We think there are loads of areas in which we can get income for investors, and we remain very positive on the potential for the fund moving forward.



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