Franklin Templeton’s Zoellner on opportunities in European Equities
Uwe Zoellner, head of pan-European equity and portfolio manager for Franklin Templeton IM, argues that volatility creates opportunities in European equity markets.
After a volatile but largely positive quarter for European equities, we remain optimistic about regional equity markets for the remainder of 2014.
We see current market volatility, which we believe is mostly a result of investor concerns about events outside Europe, as an opportunity to buy into an attractive long-term investment story, particularly given the structural reforms taking place.
We expect Europe to continue on its path of structural improvement. We have seen evidence that the southern periphery is bottoming out. Budget deficits have been reduced significantly, and most countries are now showing a primary surplus.
Greece, for instance, recently surprised markets with a primary surplus twice what observers expected. At the same time, we see that for countries like Spain the benefits of recent structural reforms are coming through.
Market liberalization and labor market reforms have improved the Spanish economy’s competiveness and, as a result, export activity has picked up and become an important driver of economic growth.
Exports of goods and services were 34% of Spanish gross domestic product at the end of 2013 versus 27% in 2007, according to data from the national statistics agency Instituto Nacional de Estadístca.
In Italy, while it has lagged behind other countries in its efforts to improve competitiveness, we are encouraged that under the new government of Prime Minister Matteo Renzi, the country is finally becoming more serious about reforms.
If Italy were to follow the example of Spain, we would expect to see another strong upward move for the eurozone economy in the coming years.
As a result, we are sticking to our thesis that Europe is in the early stages of a multi-year recovery and that we expect to see significant further upside in company profits in the years to come.
In terms of the corporate profit outlook for Europe, we believe there are reasons to be optimistic. Profits in Europe have lagged those in the United States significantly in the wake of the 2010 eurozone sovereign debt crisis.
With earnings in Europe still significantly below their 2007 peak, as the crisis subsides, we believe we should see greater upside to profits in Europe than in the United States, where earnings have already reached new highs.
A look at corporate profitability confirms this disparity, by our analysis. Profitability as measured by return on equity is still significantly below historical averages, which implies to us significant upside if our forecast is right that peripheral countries are fixing their structural problems.
However, there are reasons for concern, such as the political situation in Ukraine. As much as we share people’s uneasiness about the political situation, we believe the impact on the European economy and its equity markets will be limited to a small number of companies directly exposed to the region.
Instead, we believe the main risk for European equity markets is a severe global slowdown. To a large extent, exports drive the European economy and, therefore, global weakness could impact the earnings outlook of European companies, in our view.
At the moment, all eyes are seemingly on emerging markets where we have seen renewed uncertainty about economic growth in recent months. However, we do not see a structural risk for Europe coming out of this recent volatility.
Of course the situation differs by country and region, but in general we do not see a structural deterioration in emerging markets that would put their relative above-average long-term growth rates into question.
Instead, we see signs of overheating in certain countries and a need for governments to tackle these problems. In our view, these cyclical problems are an ugly, but inevitable, part of normal economic life, and we believe these problems are likely to be temporary.
Of course, the negative news coming out of emerging markets does impact Europe and create volatility, but we view this volatility as an opportunity and are increasingly looking at companies that are either directly or indirectly exposed to emerging markets as a source of potential new investment ideas.