European equities likely to be strong investments despite weak euro, it is claimed

News - Tax

Written by Ray Clancy

Monday, 28 June 2010 10:00

Austerity packages in Greece, Spain and the UK are likely to subdue activity in European equity markets in the medium terms as taxes rise and job security falls but emerging markets are continuing to deliver robust levels of growth, according to financial experts.

This provides a good backdrop for global demands in a number of industries, according to William Davies, head of European equities at Threadneedle.

‘Much has been made of the weakness of the euro and it is certainly true that the recent problems in addressing peripheral countries’ debt problems have revealed fault lines in the single currency. However, we firmly believe that the euro will survive its current stresses, even though a period of further weakness seems likely,’ he said.

‘A weak euro is good news for the many exporters operating in the core of Europe, as it makes them more competitive on the world stage and also increases the value of their overseas earnings. We have already seen the UK benefit from this theme. Sterling was very weak on the foreign exchange markets last year and recent data on exports, as well as quarterly results from companies with international operations, have showed the positive impact that a weak currency can have,’ explained Davies.

‘The tailwind provided by a weak currency, together with recovering growth in core Europe and the operational gearing benefits of cost cutting undertaken during the downturn, give us confidence in the outlook for European corporate profits. We foresee aggregate earnings growth of around 25% in 2010. Much of the recent volatility in world markets has been a result of investors questioning earnings momentum into 2011. We forecast a modest slowdown compared with this year, but earnings are still expected to grow by a further 15% next year,’ he added.

One of the positive points is that valuations are very attractive and he believes that aggregate earnings in 2011 should return to 2007 levels. ‘The market is some 40% lower today than it was at the earnings peak. As a result, valuations are looking attractive. Our forecasts place the European equity market on a PE multiple of 10.7x 2011 earnings, well below the ten-year average of 18.8x,’ said Davies.

‘European equities also offer the most attractive yields on the global stage, with a 2010 prospective dividend yield of 3.5%, rising to 3.8% in 2011. With 10 year government bond yields at 2.6%, equities represent excellent value relative to bonds. Companies themselves are seeing the value in markets, as illustrated by an upturn in corporate activity. We expect this to remain a feature in the medium term,’ he added.

He believes it would be unwise to ignore underweight peripheral Europe and companies that sell into those economies. ‘It is unwise to eschew these markets altogether as they feature a number of oversold companies with exposure to faster growing overseas economies. For example, there are some Spanish companies that are generating strong profits from their Latin American operations,’ he explained.

He favours consumer staples and healthcare over telecoms and utilities. ‘Given the regulatory and competitive pressures facing the latter sectors, we see them as value traps,’ he said. Cyclical exposure is coming primarily via mining and industrial companies and he is cautious on financials.

‘Our approach to investing is based on understanding the themes driving markets, analysing the business and financial models affecting companies and marrying the two disciplines to populate portfolios with good quality stocks that are well suited to the prevailing investment conditions,’ he added.