|Summary: With Europe seemingly out of the economic woods, stock pickers are taking a shine to the continent. Investment bank JPMorgan is especially bullish, calling for a 31% equity allocation in Europe.|
|Key take-out: JPMorgan estimates that even if the EU economy produces a meagre 1% in GDP growth next year, it will probably translate into 8% earnings growth for companies.|
|Key beneficiaries: General investors. Category: Economics and investment strategy.|
Last week, JPMorgan Private Bank‘s investment team identified European stocks as perhaps the biggest opportunity of next year.
Richard Madigan, JPMorgan Private Bank’s chief investment officer, says that the firm has been advising its clients to take profits in the US and redeploy those gains in Europe’s and Asia’s equity markets. Currently, JPMorgan’s equity allocation calls for 31% in Europe.
Such calls are head scratching when it was reported last week that economic growth in the Euro zone had slowed to 0.1% from 0.3% in the second quarter. Still, say the Euro bulls, it marked the first time in two years that the EU showed two consecutive quarters of growth, as pointed out by Barron’s Jonathan Buck in “Silver Lining in Europe’s Punk Data.”
Madigan not only believes that Europe will continue to chug along, but estimates that even if the EU economy produces a meagre 1% in GDP growth next year, it will probably translate into 8% earnings growth for companies. After three years of negative earnings growth, European firms are svelte and will get a significant bottom-line boost, with only marginal top-line improvement.
Also adding possible momentum to European stocks is all that money on the sidelines, itching to get in. This summer, JPMorgan sent their European investment strategist César Pérez to meet with clients in Asia, because many were expressing interest in Europe. An informal survey found that of the 150 investors in the room, 82% said they were interested in buying European equities; 73% indicated that less than 5% of their portfolio was invested in the euro zone’s equities. Pérez was surprised by the low number, but the lack of ownership should bode well for Europe, Pérez reasoned, as these eager Asian institutional investors pile in on signs of economic growth and improving profit margins.
Barron’s previously talked to JPMorgan’s CIO Madigan a few months ago, when he most liked countries in Asia, like India, Taiwan and Japan, companies on China’s periphery capitalising on the Middle Kingdom’s growth prospects. Madigan and his team continue to like these Asian countries but now think a number of developments are tipping in favour of European equities.
For one, the policy climate has changed. The continent’s politicians and ECB wonks are seriously committed to averting any real crisis, says Pérez. “The policymakers are on our side and even if the growth picture turns negative, they are committed to help,” he says, which should put a floor on the downside.
The ECB is currently suggesting it will supply additional monetary support. Last week, the central bank lowered rates to a record low, of 0.25%, and a recent Wall Street Journal interview with ECB executive board member Peter Praet indicated that the central bank could provide additional, unconventional stimulus in the form of direct asset purchases or negative interest rates. Over in the political realm, German leaders seem to have publicly backed-off the austerity drums, now that France is languishing, down 0.1% this quarter.
But to play the continent, says Madigan, be selective; the markets are littered with value-traps. “Companies which are cheap are cheap for a reason,” he says, mostly because of continued profitability issues. JPMorgan instead looks for special opportunities — Madigan believes that the big play next year will be a wave of European mergers and acquisitions — ferreted-out by Europe-focused stock-picking managers. A good 50% to 60% of JPMorgan’s global portfolio is parked with portfolio managers with broader mandates and flexibility, as opposed to passive index tracking.
Madigan and his team in particular are looking for companies with positive fundamentals obscured by Europe’s general economic weakness; such companies could rapidly become takeover targets. Jonathan Buck’s potential M&A candidates include Arkema (AKE. France), Burberry (BRBY.UK) and Man Group (EMG.UK).
If you are strategically looking for countries that are levered to a recovering Europe, Madigan also recommends positioning in Central and Eastern Europe, like the Czech Republic, Hungary and Poland. They are likely to see an outsized benefit when Europe’s economy improves, since their manufacturing bases export heavily within the euro zone, Madigan says. In this group, Barron’s Jonathan Buck identifies KBC Group (KBC. Belgium) and colleague Prabha Natarajan likes Eurocash (EURO.Poland) and Bank Pekao (PEO.Poland).
A summary of Madigan’s thesis: The old continent has been so battered and oversold these past few years, careful stock-pickers should be able to realize substantial value.
This article was first published in Barron's, and is reproduced with permission.