Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Stuart Mitchell, manager of the SWMC European Fund, explains why despite economic concerns there are investment opportunities to be had in Europe.
While fears over the health of the European economy have picked up in recent weeks, we are a little more optimistic than most about the growth outlook. This is coming from the company meetings we are having on the ground.
We feel Europe is recovering as expected, despite the panic seen in the last couple of months following the poor GDP prints in Germany and Italy. While we were anxious this could have been a more widespread phenomenon and Q2 company earnings could be affected, the second quarter earnings season was quite positive.
Company expectations have not changed from about six months ago and there remains reasonable optimism about 2015. There is certainly a different opinion when you speak to people on the ground, rather than all the current media headlines.
Europe Unlikely to Slip Into Deflation
Again, the impression we are getting from companies is that deflation is less of a risk than many currently perceive. Clearly in the peripheral countries, which have faced terrible austerity in recent years, prices are not increasing and are falling in some cases. Having said this, these are the countries recovering the fastest in Europe now.
At the other end of the spectrum, the European powerhouse Germany is operating at full capacity and wage growth is running at 3%-4% levels. The Continent is unlikely to slip into deflation in our view. The most effective companies are beginning to bounce back and the core of Europe is still seeing some price increases.
Domestics Still Significantly Undervalued
We continue to believe the best opportunities today are in the domestic areas of the market. These companies – whether it is banks, home builders or utilities – are the ones we have highest conviction about.
Our thesis has remained fairly constant for about two or three years. Back in 2012 we felt the growth stocks exposed to emerging markets were way overpriced, while there was very little expectation for recovery in domestic plays. This is still largely the case.
We believe banks are the best way to play the domestic recovery, and we also have 30% in Spain and Italy, with a large part of this in Spanish construction.
A relatively recent investment we have made is in utilities, at about 15% of the portfolio, with a key bet on telecom companies. There is a great opportunity for the old incumbent privatised telecoms – such as Deutsche Telekom (DTE) and Telecom Italia (TIT) and Orange (ORA) – with a more supportive and benign regulatory environment and improvements in technology.
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