European equities have come under pressure lately. The broad European market was on the verge of entering “correction territory”, commonly defined as a pullback of 10% or more from recent highs. Most of the selling has been attributed to the unrest in Ukraine (Russia is the largest supplier of natural gas to Europe) and renewed worries that the European economy is stalling.
BSW currently has an overweight to Europe versus our benchmark, the All Cap World Index (ACWI), in BSW Growth Portfolios.
Despite the recent weakness (and now even more so because of it), we believe that there is good value in European stocks!
It is our job to look through the noise and not let the barrage of made-for-TV headlines drive our decision making process. To that end, let me shed some light on our thoughts surrounding Europe and the rationale for maintaining your exposure to the region:
- The ECB is committed to halting deflationary pressures across Europe; therefore further monetary easing is not only possible, but probable – especially given July inflation figures that came in at 0.4% versus the stated ECB target of 2.0%.
o Additional stimulus measures would be a tailwind for stocks and would support a weaker Euro, which would be a boon for European exports. (Almost 50% of European company revenues are derived from the U.S. and Emerging Markets.)
- EU profit margins are starting to improve but have yet to reach the unsustainable high levels of U.S. corporations.
- Europe still looks attractive on a normalized PE basis. Current PE levels are still below 15 year average readings.
- Merger and acquisition activity across Europe has increased dramatically this year and consumer and business confidence readings are well off their lows. Both data points are indicative of an improving economy – one in which business leaders are willing to take risks and invest capital.
- 2Q14 year-over-year earnings growth has clocked in at a healthy 7%, despite flat revenue numbers. Therefore, any uptick in sales going forward should translate into solid earnings growth.
- Finally, and most importantly, we are investing in European domiciled companies, not Europe!
o The vast majority of your European exposure consists of well-managed, large, global franchises whose fortunes are not tied to the European continent, such as Nestle, Unilever, Novartis, and GlaxoSmithKline.
o The dividend yield on our basket of large cap European stocks is ~4.00%! – nearly twice that of the S&P 500. And this dividend is not in danger of being cut, due to the fact that these corporations are sitting on high cash balances and have trimmed debt levels to more manageable levels. With bond yields so low around the globe we feel that investors will not be able to resist a 4.00% dividend yield, with the added benefit of stock growth potential. Of note: German 2- year bonds recently yielded a negative 0.006%, meaning investors actually receive back less than they invest!
To summarize, we remain confident in our overweight to Europe. We are monitoring European equity markets closely. If the news flow gets gloomier and European stocks get cheaper, we may expand our position further.
We hope this helps to shed some light on BSW’s positioning and your portfolio holdings. Should you have any questions, or if you would like to discuss your BSW portfolio further, please do not hesitate to give us a call. We are happy to help.
-Senior Portfolio Manager, Director of Developed Foreign Markets