On the face of it, there is little reason to rush into investing in the EU. The union’s members appear beset by political and economic challenges, from managing the pandemic properly to reviving technological innovation.
This time of year sees many companies announce their results for the first quarter and, often more interestingly, their observations about prospects for the months ahead. In the calls I’ve taken part in, broadly speaking, Asian companies have reported continued buoyant conditions; US companies have spoken of a strong recovery; and European managers have bemoaned the slow vaccine rollout.
A section of the British press has been playing up Brexit Britain’s triumph in the Great Vaccine Handicap race. More than half the UK population has received its first jab. We have vaccinated almost as many people as Italy, France and Spain together. Indeed, at 2.4m jabs a day, it could take a further two months — to the end of June — for Europe to inoculate half the population with one jab.
Domestic recovery, especially in southern Europe, needs consumer spending to restart and related jobs to return. This is particularly important for younger people. Unemployment among the under-25s averages more than 17 per cent across the EU. It is over 30 per cent in Italy and nearly 40 per cent in Spain, according to EU statistics.
But, as far as investors are concerned, all is not as bad as it seems in continental Europe. Despite the gloom, the Stoxx 50 European index has risen nearly 13 per cent so far this year, compared with the UK FTSE index at only 7.7 per cent and Wall Street’s S&P 500 at 11.3 per cent. What is drawing investors?
Compared with their global peers, European companies tend to be on lower multiples for current earnings. Look at consensus earnings multiples for stocks in similar industries. Adidas, the German sportswear manufacturer, trades on a hefty 35 times this year’s earnings, but Nike in the US is on an eye-watering 42 times earnings.
Banks have a large weighting in European indices and large banks such as France’s BNP Paribas trade on 65 per cent of their book equity, while JPMorgan in the US trades on 185 per cent. Investors have noticed and sense a bargain.
But cheap does not necessarily mean good value. Before dashing across the Channel like an excited shopper hunting for duty-free Gitanes and Château Plonque, investors should check for growth.
They may struggle to find it. The major European indices enjoy little propulsion from technology stocks and are dragged down by financial companies.
Laying aside recent revelations about undisciplined lending to hedge funds, banks are required to hold large amounts of money in reserve. The proportion that must be held in European government bonds has increased over the past decade.
The annual yields on 10-year bonds across the region are currently: Italy at 0.78 per cent; Spain, 0.39 per cent; France, 0.08 per cent; and Germany at minus 0.26 per cent. Taking deposits, even if paying nothing in interest to the depositors, and investing in government bonds will not generate the revenue to pay for all those buildings and staff that banks tend to need.
Life is even tougher for insurance companies. These have historically reassured long-term savers that their annual premiums invested in such bonds will, after costs, be worth more when the savings policies mature. It looks like many Europeans will reach retirement in the next few years disappointed. And so may shareholders.
So where does the appeal lie in European markets? One area where Europe leads the world is in fashion. Our European selection contains Louis Vuitton, Hermès and Richemont, owner of the Cartier watch brand. In its first-quarter financial statement last week Hermès announced that leather goods sales had risen over 33 per cent year on year. It seems that the better off are back shopping with vigour.
In reality, much of that growth has come from Asia, and this highlights an opportunity for the region. Able to stand back from superpower posturing, businesses in Europe may find it easier to trade with both North America and Asia.
There are other interesting niches, too. The low yields on government bonds that are encumbering banks and insurance companies are the result of European reliance on central bank funding since the financial crash of 2008. This operation may now be reaching its zenith with the €1.8tn “Recovery plan for Europe”. Hopefully, much of this extraordinary stimulus will be spent enhancing productivity and investing in technology-led businesses rather than propping up uncompetitive companies in politically sensitive areas.
It is likely to lead to heavy investment in the infrastructure to support an accelerated transition towards a lower-carbon economy. There are European businesses that are well positioned to benefit from this. One we own is Legrand, a producer of electrical equipment needed in sustainable and energy-efficient building and infrastructure. It should see earnings rise from €1.16bn this year to €1.38bn next (19 per cent growth), leaving the stock on less than 13 times earnings. By comparison, Emerson Electric, many of whose divisions operate in similar areas in the US, trades on around 22 times earnings for similar earnings growth.
Mid-cap stocks that might have an exciting future include Eurofins, an expert in purity analysis and environment and food testing. Another is Hexagon, which makes measurement equipment and the software needed for automation systems. Neither looks especially cheap right now, but they show t there are innovative and entrepreneurial companies in the mid-cap arena, even if the larger European stocks often seem rather antique.
Investors cannot discount the risk of further financial crises in Europe. They should also recognise the fact that governments there are not exactly wedded to free market principles. In France the government has prevented foreign acquisitions, even pronouncing on one occasion that yoghurt is a French national strategic asset. Protecting management teams from takeover does not tend to lead to strong performance.
European markets have had a good year and in aggregate are still relatively inexpensive. But the companies that are growing are unlikely to be the cheapest. It is easy to be drawn to low valuations. Don’t be afraid to compromise on price in favour of prospects.
Simon Edelsten is co-manager of the Artemis Global Select Fund and Mid Wynd International Investment Trust