Pockets of opportunity in Europe, Emerging Markets – Franklin Templeton

Maintaining the right mix or balance of assets in a portfolio to achieve a desired goal can be a challenge, particularly when the markets are constantly shifting, according to Lisa Myers, Executive Vice President,
Templeton Global Equity Group.

In early 2014, there seemed to be a few more areas of concern than we saw in late 2013. There has been some questioning of the stability of the US economic recovery, and of course, worries about prospects for emerging markets. That said, we are still finding plenty of reasons to be optimistic about the global equity outlook this year, and we are still finding values.

We feel confident enough in the story of the US economic recovery from the 2007-2009 financial crisis that it almost sounds strange to us to still call it “recovery.” It feels pretty stable, considering the revival we’ve seen in the housing market, the improvement in household incomes, the deleveraging on the private sector side, and the impressive amounts of cash US corporations have on their balance sheets.

That being the case, US valuations have come up, and while we still like the United States, as value investors we feel more strongly about European equities. European equity markets also performed well in 2013, but according to our analysis, Europe appears generally more compelling than the United States in terms of where earnings are, where margins are, and the amount of catch-up European companies continue to do in relation to the United States.

As our team comes together to discuss opportunities for our portfolios, we still feel that the most compelling opportunity set lies in Europe. We have been particularly interested in European financials on the equity side for a number of years, beginning at a time when it was considered quite contrarian. While not as inexpensive as they were a few years ago, we think there is still plenty of value in European financials, as some European banks are still trading below one times book value.

A large French bank is one example of the kind of value we are seeing today. The company has rebuilt its capital base and has been paying back shareholders through dividends. Today, it has a sizable amount of excess capital on its balance sheet and has been bolstering holdings in existing subsidiaries throughout Europe.

Additionally, cash on balance sheets is generally high for many companies both inside and outside of the United States, and we think many companies may funnel some of that cash into technology. When we see heightened volatility in the economy overall, it can keep CEOs on the edge of their seats, hesitant to commit to spending. However, as we look at technology, on the hardware side, PCs and desktop technology are aging; the average age of equipment is quite high. While PC sales have fallen off a cliff due to sales of tablets and other devices, we have seen a lot of data to suggest that we should see some PC replacement coming through. And, as companies become more cloud-based, it should bode well for companies engaged on the software and service side.

We also continue to like pharmaceutical companies, which have rerated to some degree over the past year or so-that is, awarded a higher earnings multiple-but believe they still do not fully reflect secular tailwinds ahead such as aging demographics in many countries, the implementation of the Affordable Care Act (“Obamacare”) in the United States, and growing numbers of health care users in emerging markets. In some cases, we’ve been shifting our focus from large pharmaceutical stocks to biotechnology and healthcare equipment companies.

Lastly, energy is an area that’s been fairly contrarian. Yet, our analysis shows that oil service companies are being penalized for, and their valuations reflect, near-term supply and demand dynamics without consideration for numerous longer-term trends, which we believe could support sustained growth of oil services. More deep-water discoveries, the shale revolution and fracking, oil sands and the increasing importance of national oil companies all portend a higher concentration of oil services over time, in our view.

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