There’s a simple explanation for that price-to-book gap: American firms are vastly more profitable, with 13% trailing operating margins, while their European peers generate 8.8% operating margins, according to Saba.
He cites U.K.-based Unilever PLC as an example of a comparatively undervalued European multinational. The consumer products giant has exceeded consensus analysts’ forecasts for two straight quarters, in part because of margin gains accruing from euro-related expense savings.
“Manufacturers with an asset base in Europe and a strong sales base in the U.S. are in a great position,” Saba says.
Tocqueville’s Hunt points to industries such as building materials, media, industrials and consumer discretionary stocks as industries that should hold appeal as the euro zone recovery takes root. “We like the current valuations in these sectors, and there’s ample room for profit margin improvement,” he says.
Kotok believes that the pharmaceutical, machine tool and technology sectors hold strong appeal right now. He is also focused on companies with a strong export focus. “A company like Siemens could be a classic beneficiary,” he says.
Joseph Calhoun, CEO of Alhambra Investment Partners, has been focusing on European telecom firms. “Companies such as Vodafone, Telefonica de Espana and Deutsche Telekom offer great yields,” he says, adding, “It’s a very stable sector in terms of revenues.”
A Vote For France
While countries such as Ireland and Spain (and to a lesser extent Italy) get credit for structural economic reforms, France has remained something of a punching bag for strategists, who note the country’s sclerotic bureaucracy and restrictive labor laws. Yet even France is starting to give off a brighter sheen, with recent economic reports suggesting an upturn has taken root.
Analysts at Goldman Sachs point to a “combination of cheaper oil prices, weaker exchange rate, lower interest rates and reduced fiscal drag” that is boosting French business confidence. They believe that the stage is set for a steady reduction in France’s stubbornly high unemployment rates, which could trigger a boost in consumer spending.
Indeed, the entire Continent is in dire need of robust job creation. “The real thing holding back domestic demand is the lack of job growth,” says BBH’s Chandler. The official euro zone unemployment rate stands at 11.1%, a three-year low, though that is still roughly twice the levels seen here in the U.S. Fully 18 million people in the currency zone remain out of work. Chandler believes that “cutting red tape, further labor reforms and other measures are the key to future employment gains.”
What Could Go Wrong?
One of the reasons the ECB is comfortable with plans to spend more than 1 trillion euros to reflate the economy is the utter lack of inflation (which currently stands at 0.2%). ECB president Draghi aims to stimulate the economy to the point where prices are expanding at a 2% annual pace, a clear sign that Europe’s “animal spirits” have returned.
But what if growth begins to wane, even as inflation starts to pick up? That could set off big alarm bells. We’ve never seen what happens when a central bank’s balance sheet greatly expands without any tangible impact. This “pushing on a string” scenario is the greatest risk that strategists see in pegging a European rebound. In a worst-case scenario, further economic weakness, coupled with Europe’s massive current debt loads, will lead bond vigilantes to pursue a ruinous spike in interest rates.
Yet for now, all signs point to early stage growth. Economists are closely monitoring the nascent upturn, and once it appears to be sustainable, European companies will have the economic environment to expand operating margins, which should lead to higher valuations for European equities. That backdrop makes this a fine time to give Old Europe a new look.
Europe Rumbles To Life
September 1, 2015
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