Read more from Global Equities Week here.
At a recent panel discussion held at Fidelity’s London offices, Stewart Cowley, the head of fixed income at Old Mutual Asset Management who described himself at the 2011 Morningstar Investment Conference in London as “a bond manager who currently doesn’t like bonds”, offered European equities as his “top tip” for 2012. Cowley was echoing comments from Cazenove’s Chris Rice, who when pushed to narrow his predictions for 2012 European equity performances down to one scenario said his money would be on a 15% increase in European equity markets next year.
European Equities: The Ones to Watch in 2012?
It’s that time of year again: a time when the world’s asset managers proffer their hopes and fears for the year ahead. This year, however, rather than confidently placing their bets on particular assets, regions or sectors, asset managers are instead forced to talk of ‘scenarios’—ranges of potential outcomes rather than absolutes. We all know only too well the pain and brief jubilations that the world’s equity markets have endured in 2011. Yet there’s still no sign of light at the end of the tunnel and global equity markets are set to continue their rollercoaster ride in the face of such huge uncertainties as the future of the eurozone, the lack of U.S. cohesion regarding deficit-reduction plans, and a forecast soft landing for the Chinese economy. In such an investing environment, Cowley, who manages £558 million in the OMAM Global Strategic Bond Fund (rated Bronze by Morningstar analysts), Rice, who is responsible for pan-European equity strategy portfolio construction at Cazenove Capital and manages £920 million in assets in the Silver-rated Cazenove European Fund, and Trevor Greetham, asset allocation director at Fidelity Worldwide Investment whose Multi Asset Strategic Fund manages £586 million, were loath to be pinned down to specific forecasts when participating in a recent panel discussion hosted at Fidelity’s London offices. However, the bond, equity and multi-asset managers, respectively, broadly agreed that given current valuations European equities could be the ones to watch for 2012.
While Cowley picked European equities as his top tip for 2012 and Rice predicted a 15% rise in European markets next year, the latter’s forecast came with the caveat that the alternative could well be a drop of 20%, depending on the outcome of the eurozone sovereign debt crisis. Given such a broad range of outcomes, Greetham made a point of repeatedly highlighting the importance of diversification and multi-asset strategies to prepare for all eventualities.
Where In Europe?
Of course the three managers mentioned so far aren’t the only ones looking at European equities. In a recent Global Equity Strategy research note from Citigroup, the investment bank’s analysts said they still believe that investors may be too sanguine on some of the issues facing Europe and they would wait for a policy response rather than second-guess politicians. However, they added that while they currently remain underweight on Continental European equities, they see particular opportunity in Italy and Germany.
“Italy’s valuations look very attractive—Italy trades at a 45% discount to Continental Europe on price-to-book [ratio] (and at a record discount to Spain),” Citigroup analysts wrote. “Italy’s equities performance relative to the euro-area is at an all-time low—and it is only 6% above its record low relative to Spain,” they added.
Citigroup pinpointed Italy as possibly being the best, very high risk trade, and highlighted potential opportunity in Italian stocks Enel (ENEL) and Lottomatica (LTO).
Cazenove’s Rice also pointed to value in Italy equities: “They are priced for Italy leaving [the EU],” he said. “If Italy leaves, some money will be lost but they will then have lira; and if the euro breaks up, the assets that you definitely do not want for the rest of all time is German equities… Imagine what the deutschemark will be [valued at] if we had it.”
Regarding Germany, Citigroup said it finds the country’s leading index the DAX to be the fifth cheapest market in Europe, after Greece, Italy, France and the Netherlands. The firm’s analysts further stipulated that they believe the euro will weaken further and the DAX will be the main beneficiary of such a currency move. Within Germany, Citigroup listed Porsche (PAH3), Heidelbergcement (HEI), Allianz SE (ALV) and Thyssenkrupp (TKA) as four DAX stocks that look “abnormally cheap” on 12-month forward P/E relative to both the peer group and the market.
Discussing global equities as a whole, the Citigroup report noted that co-ordinated quantitative easing from both Europe and the U.S. would be “a big buy signal for equities—the only cheap inflation hedge.”
An Alternative View
That valuations of European equities are cheap at present is not a contentiously-held view, but that doesn’t mean investing experts are ready to put their hands in their pockets just yet. Bill O’Neill, CIO for Europe, Middle East and Africa at Merrill Lynch Wealth Management in unveiling the firm’s 2012 outlook agreed that eurozone equities are cheap and sentiment towards them are already at rock bottom, but warned that it is too early to invest in the region due to its high risk. “In selecting equities for 2012, we are recommending a focus on large cap companies with strong cash flow and growing dividends,” O’Neill said, adding that Merrill Lynch Wealth Management EMEA suggests overweighting U.S. and U.K. equities to be most effectively positioned for next year’s investing environment. U.S. large caps are the firm’s top pick, reflecting their more reliable performance in meeting analysts’ earnings forecasts than peers elsewhere.
But while Bank of America Merrill Lynch looks to the U.S. and U.K., OMAM’s Cowley has become disillusioned with the latter’s stock market. “I find the problem with the U.K. market is that it always lags on the way up and falls more than anyone else on the way down,” Cowley said at the Fidelity debate. “Over time I have lost faith in the U.K. equity market in that sense.” He added, however, that in addition to European equities he felt the investing environment over the coming year will be a great one for small-cap U.K. companies that are linked directly to foreign economies and not just the domestic British economy.
And what of emerging markets? Citing a plethora of studies that find close to zero correlation between economic growth and stock market return, Cazenove’s Rice noted that emerging markets may well be where the economic growth is, but that what’s more important when investing is the price at which you buy an investment. “It is the price you buy in at and not what your expectation of 30- or 40-year growth is,” he stated, adding that no-one can accurately predict what will happen over such a long time frame.
The outlook for 2012 from Andreas Utermann, global CIO at Allianz Global Investors/RCM, states that: “emerging markets are likely to remain strategically important and the slowdown in economic activity will end, in our opinion, in a soft rather than hard landing. The report, entitled “A Difficult Year Ahead in 2012”, adds that this positive view on emerging markets leads the firm to a strategically positive view on emerging markets assets, be they equities, bonds or currencies, valuations notwithstanding.
Diversify—If You Can
So European equities are super cheap, but also super risky; U.K. equity valuations offer opportunity, but are unreliable compared to their U.S. counterparts; emerging markets continue to offer growth, but economic prospects don’t necessarily translate into equity performances. What is an investor to make of such an unpredictable investing environment? One thing all asset managers seem to agree on is the need to diversify a portfolio to cope with a multitude of potential outcomes posed by this fragile time. Yet even diversification is hard to come by in such a scenario. “The task of ensuring diversification across investment portfolios is complicated by a shrinking set of ‘safe havens’,” said O’Neill of Bank of America Merrill Lynch. “We are stressing yield, quality and growth in selecting equities.”
To ensure your portfolio is adequately diversified, use Morningstar’s X-Ray tool to analyse your portfolio and see your asset allocation across asset classes, geographies and sectors.
