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Eurozone companies appear unbothered by macro bad news

16/10/2012

Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

Investing for the long-term has a good deal to commend it - but it can make it tricky to find something new and interesting to say when it comes to writing the quarterly review for our investors. This time around, however, I did get the easier, purely factual job of highlighting the more high profile events of the preceding three months.

The first thing that struck me as I did so should surprise no-one. Every notable event has been macroeconomic – the latest programmes of quantitative easing (QE) in the us and japan, another Eurozone acronym in ‘OMT’ (outright monetary transactions) in other words, the European central bank’s plans to shore up the region’s shaky bond markets, job reports, business sentiment indices and so on and so forth.

The fact that so many investors feel they have to react to these events in such a short-term way is quite depressing – but also quite interesting. Take the latest set of macroeconomic revelations, which appear united in their negative tone – weak sentiment, poor growth, and limited job creation – so why have equity markets been edging upwards?

One of the more staggering numbers I have seen recently is analysts’ consensus forecast for profit growth across Eurozone countries. Ask most people to guess what that might be and you would probably hear a small (or maybe even a big) minus figure. People see Greece imploding, Germany slowing down; the aforementioned shaky bond markets and conclude that the Eurozone is a disaster.

And yet, that consensus number is in fact plus 15%. Yes, of course that is improbably high and, yes, it is bound to come down over time for all the reasons we know about. But, even so, it would need to come down an awfully long way to go negative and, as we also know, Europe is not an expensive market precisely because everyone is already so worried.

Whatever may be happening across the Eurozone at the macroeconomic level, its companies would appear to be hunkering down and getting on with business. The question for investors then becomes one of valuation – what are they paying to own these markets? – And, courtesy of analysts at Morgan Stanley, we can tell you.

They have looked at one of our favourite valuation metrics, the ‘Graham & Dodd P/E’ – a long-term price/earnings ratio that, rather than referring to a single year’s profit number, uses an average of 10 years to smooth out the inevitable peaks and troughs and paint a more representative picture – and concluded that while the Eurozone offers “extreme risk”, it also offers “extreme value”.

Setting aside Greece as something of a special situation, which is on a P/E of 2x, Italy, Portugal and Spain all trade on around 8x while France is on less than 12x. These are all markets that look inexpensive in the context of history – and also compared with the 15x of the UK, 16x of Germany and 18x of the US.

To put this all in context, if profit growth next year fell from that 15% number to something more like 5%, then corporate  profits across the Eurozone would be exactly where they were three years ago, which does not seem so bad. People look across the channel and gain the impression the world is ending – and of course it still very well may do. Nevertheless, it is odd how far market perception has diverged once again from the reality of hard numbers.

Author

Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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