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Europe: Elephant in the chambre

European equities are on a big discount to US equities. Is this a buying opportunity or are other factors at play?

Europe: Elephant in the chambre

Europe is an investment opportunity, according to several of the biggest firms in our Top 100 list this year.

Shane Balkham is head of portfolio construction at one of these firms, The Beaufort Group. In a related article for the New Model Adviser® website last month, I quoted Balkham as follows:

‘We are tactically overweight Asia and Europe in equities. We mainly look at price-to-earnings and price-to-book ratios. On a valuation perspective, they have a greater safety margin than the UK and US. They are less expensive and have a higher probability of upside than downside.’

He also considers macro-economic factors. In particular, he believes Europe is behind the US in its recovery from the financial crisis, and so has further upside potential.

No techs appeal

Balkham’s valuation viewpoint gets some support from the fact the Stoxx Europe 600 index currently trades on just 15 times forecast 2017 earnings. In contrast, the US S&P 500 index trades on 22 times.

This is a massive discrepancy for two such developed markets. There may be, though, a reason for it.

‘The elephant in the room is technology,’ said Stephanie Butcher, manager of several Invesco Perpetual European income funds.

Ian Ormiston, Citywire AA-rated manager of two Old Mutual European equity funds, agreed: ‘You’re absolutely not buying Europe for technology.’

Little IT exposure

Ormiston pointed out technology comprises 25% of the S&P 500, but just 4% of the Stoxx 600. Butcher referred to research from Italian Bank UniCredit. This shows information technology has, since Mario Draghi’s pivotal July 2012 speech, had the highest returns of any global sector, at 140%. Draghi, president of the European Central Bank (ECB), then said: ‘The ECB is ready to do whatever it takes to preserve the euro.’

In other words, European markets have little exposure to the sector that has made the biggest contribution to recent global stock market growth. Moreover, the European technology sector is, in general, nothing to get too excited about.

Ormiston said Germany’s SAP, which makes business intelligence software, ‘is a market leader, very profitable and world class. But it’s closely related to growth in gross domestic product [GDP]’. He added mobile infrastructure companies Nokia and Ericsson ‘are effectively value stocks now’ and said information technology services firms Capgemini and Atos ‘are just macro driven and not dynamic’.

Butcher said the technology driving growth is the consumer platforms Amazon, Facebook and Google. ‘In Europe we don’t have platforms,’ she said.

Key component

But Anis Lahlou-Abid, Citywire + rated co-manager of JP Morgan Europe Dynamic Technologies, does find opportunities in European technology. ‘Europe is a continent of enablers,’ he said. ‘It has companies that provide components and services to groups like Amazon, Facebook, Google and Tesla.’

Lahlou-Abid cited semiconductor maker Infineon, which supplies components to US electric car manufacturer Tesla, as an example. Meanwhile, he pointed out Capgemini trades on 15 times forecast earnings for 2018, while S&P-listed rival Accenture trades on 22 times earnings.

Butcher added that consumer platforms are disrupting traditional business models. This, she said, has led to the deratings of some sectors where there is a sense that technology will change the way we do things.

‘Do we think every advertiser or food retailer will be disrupted?’ she asked. ‘If we don’t, then we see opportunities, as there are valuation discounts in the market.’

Butcher also said this perceived disruptive technology can benefit some traditional companies. ‘The market isn’t thinking about how technology can help existing companies improve their businesses. That’s where the interesting debates are to be had and potential opportunities can be found.’

So, while there seem to be good reasons for Europe’s broad valuation discount, opportunities still remain for astute stock pickers.

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