LatAm and US investors consider Europe’s potential investment opportunities in a totally different light than European investors. According to Neil Dwane, Portfolio Manager and Global Strategist at Allianz GIobal Investors, there is widespread frustration on the part of international investors regarding the Old Continent, which is why they are careful when considering their portfolios’ exposure to European equities.
“Nobody questions the fact that European companies are well managed and that they have attractive valuations, which are two reasons that make Europe seem like an opportunity. But if we look at their performance, we see that it was lower than that of the US. That has generated a lot of frustration. In addition, the political situation has become more complex, which does not help to change investors’ perception that Europe is more fragile than other regions as far as a hypothetical crisis or recession,” explains Dwane.
In his opinion, the political situation will not improve within the next few years, so it is logical that investors are worried, especially when the ECB seems to be part of the problem and not the solution. “It seems that we will have a low interest rate environment for quite some time, which will affect the eurozone’s banking system and weaken its margins”, Dwane said.
“Of course, we cannot forget that for the economy to be healthy, banks must also be healthy. If they do not allow banks to become solvent again and raise capital efficiently, they will not be able to cope with failed loans, and the economy will weaken. If we go back about ten years, I think the British and the Americans were able to fix their banks faster and more efficiently than the eurozone,” adds the Allianz GI strategist, referring to the structural impediments that are holding back Europe’s performance and attractiveness.
Clouds on the Horizon
Brexit, and the image of the European Union (EU) that is projected with it, is the other great failure that he sees. He firmly believes that, despite wanting to show robustness, the EU, by making this process complicated and difficult for the UK, is sending a message of weakness and setting a precedent that can make other countries doubt whether they really want to belong to the EU club or not. This “weak continent” projection is reinforced because US President Donald Trump is positioning the US as a minor supporter of the EU and of NATO.
“What I see at the investment level is that, after the negative interest rates implemented by the ECB, the bond market doesn’t provide any returns. When the same happened in the US, equities were strengthened and gained attractiveness; however, we don’t see this rotation happening in Europe. Europeans have not rushed to invest in equities, and that makes investors wonder why foreign investors would invest when locals don’t,” Dwane adds.
But Europe is not the only region where there seems to be heavy clouds. In general terms, central banks have ceased or paused restrained their monetary normalization: the market considers that the Fed can lower interest rates, the ECB announces new Targeted Long Term Refinancing Operation (TLTRO) operations, and the Bank of Japan faces the threat of a recession. In the US, the economy is still patchy, showing it s clear sensitivity to higher rates.
Dwane admits that we are facing a new swing towards a global low rate environment since the Fed announced a more dovish tone, which may arouse more interest in European equities. “I think that if we return to the previous cycle right now, with a relaxation of the monetary policy and greater QE, this time, valuations will be very important for the investor. The money will go where it has the highest return potential and you will find very cheap and attractive valuations in Europe and, at the same time, expensive valuations in the United States. That should make international investors return to Europe, which will remain attractive for its fundamentals and its valuation, minus the banking sector, but it will have to undertake the task of managing political issues,” he argues.
Is Europe an opportunity?
In this regard, Dwane maintains that European equities can complete a US core portfolio of stocks more inclined towards tech and health companies, since the US is not as strong in, for example, industrial or consumer companies. He points out that, in his analysis of the next three to five years, regulation and politics will begin to mix with many of the aspects that have now driven the US economy, especially in the social media and tech industry, which will end up translating into lower yields as the late cycle US economy slows further.
Dwane points out that many industries are experiencing strong disruption, which, he believes, will generate more opportunities in Europe because there are still many companies that must reinvent their business models and because the tech industry is less concentrated than in the US. However, he added, “we believe that investors are not focusing on the great disruption that I call the Technology Cold War between the US and China, which is based on the assertion that China has been and is stealing technology from America. I think that this environment is causing tighter margins and that we are seeing some mature technological cycles that are coming to an end,” he explains.
Dwane admits that he has always had a foot in Europe, but he won’t risk analyzing the continent, and warns that the important thing is “to know what the European project is, how Europe 2.0 – a Europe that responds to global challenges – will evolve, and who is going to pay for it”, he states. When it comes to his outlook for the future, he believes that if global growth continues to decline, market returns will be quite low: European and Japanese bonds will be negative, and Treasuries will not be offering enough benefits. "What we have to consider is whether we have the right assets and positions in our portfolios and those companies with a business model that can guarantee sustainable growth. I think that the environment for US growth stocks has changed and future yields will not be as compelling; however, I believe that the opportunity for dividend shares is being lost, which is a less risky way to invest in equities. I also believe that the Fed’s new tone is telling us that, for the USA economy, the second half of the year may be satisfactory, and this has supported the rebound in the equity market,” he adds.However, with China stabilizing and Japan stalled and the USA lackluster, the rest of 2019 is not set fair just yet to continue to take full on risk, hence preferring income from attractively valued equities.
Regarding emerging markets, Dwane points out that they are also an interesting asset and should be approached through a meticulous selection, analyzing political, industry and regulatory risks carefully. He emphasizes that it’s important to value the opportunities, taking into account the global economy’s health and the dollar’s evolution and strength. “I believe that by applying the same approach to stock selection as in other markets, you can find many companies [in the emerging markets] that trade at very low valuations compared to their international peers. Of course, I think that following an index must be avoided, because otherwise, you cannot react to a political change or to currency valuations, and I would look for specific themes to build the portfolio’s exposure,” he concludes.