Stockpicking season in Europe

Hermes Fund Managers says it sees continued opportunities for stockpickers in Europe, although there are still questions over broader economic recovery.

Hermes Fund Managers, the London, UK based multiboutique manager,
has said in a recent briefing that it remains wary of the outlook for the eurozone, but that for stockpickers the environment continues to facilitate adding alpha.

Neil Williams, group chief economist, pointed to research suggesting that the eurozone will continue to lag other developed markets such as the US, UK and even Japan through 2014 and 2015.

“The shoots are growing, but need watering,” he says, adding that it
could still take some years before the eurozone fully recovers from the financial crisis, given that in real terms the GDP of the single currency
region still remains mired at 2007 levels, while, say, the US has seen much faster improvement.

Key to the US improvement has been the Federal Reserve quantitative easing programme. Even with discussion of tapering, the forecast is for
some $460bn in additional QE stimulus through 2014, taking total QE to
some $4.4trn.

Williams says based on figures published by the Fed itself, this points to a
total effect on the US economy equivalent to cutting interest rates by -546 basis points.

Putting this against the picture in the eurozone; while it may be that competitiveness has been improved in certain member states, as wages have come down in real terms, there is a sustained challenge in the value of the currency.

The ECB is still following a relatively tighter policy than the US, which is one reason the euro has remained relatively strong, making it harder to send exports outside the eurozone.

Andrew Parry, CEO Hermes Sourcecap, acknowledged that while general momentum in economies can be a powerful factor what matters is what the managers of companies say, such as whether or not they are hiring more staff.

Clearly, investors around the world have warmed to the idea of investing in European equity, he says. However, Hermes putout a note as far back as 2012 suggesting that Europe is a place where companies continue to make things that people want to buy.

Then, the challenge was the fear of eurozone contagion putting off investors. More recently it has been a case of, for example, US global equity managers putting record levels of net investment into European equities.

There remain certain dangers, however, and investors need to be absolutely sure they understand what is happening at the company level.

Parry says that simply comparing indices such as the S&P 500 against the Euro Stoxx 50 to suggest Europe is cheap versus US equity does not give the full story.

For example, while Ireland may have returned to international debt markets, profits at the company level in Spain remain below precrisis peaks. This means there is momentum in the market, but not necessarily the depth of value suggested by the comparison between indices.

The recent reporting season pointed to about half of companies beating sales targets and about half not; Parry describes it as being less than the boom suggested by the performance of European stockmarkets over the past 12-18 months.

Thus, investors need to look to individual companies, rather than take a top down view. So-called ‘stale bulls’ in emerging markets may seek to sell during the coming summer, which leaves Europe as the default choice for
many global equity managers.

But the danger signs are there, such as the high level of dispersion of returns in key sectors such as banking and industrials. However, Parry adds that a dose of fear is to be welcomed in stockmarkets, because it creates
pockets of mispricing that creates opportunities for stockpickers.

It is not difficult to find good companies, driven on by good development and under good management. The question rather arises over valuations, given what has happened to prices on stockmarkets.

Both growth and inflation remain low in real terms. Should they rise then it suggests companies will fare better overall, but it may be that some companies do better than others in such an environment.

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