Why Europe still offers opportunities

Despite Europe’s ongoing economic and political challenges, investors can find opportunities by focusing on European companies taking steps to improve their businesses, portfolio manager Alessandro Valentini says.

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“Europe still offers very interesting opportunities for us,” said Valentini, a PM at Causeway Capital Management in Los Angeles, Calif., in a Jan. 16 interview. He manages the Renaissance Global Markets Fund.

“It is important to break down that over the last five years, the return on equity for the MSCI EAFE Index has improved by over 1%, while the price to book has actually decreased by 13%. This implies that while the quality of the companies has improved, the valuation has shrunk.”

The MSCI EAFE Index captures large and mid cap companies in 21 developed markets, excluding the U.S. and Canada. It ended 2018 down 13.79% after finishing 2017 up 25%. Europe makes up a large component of the index, Valentini said.

In contrast, Valentini noted the MSCI USA Index has seen returns improve by 1.6%. However, price-to-book valuation has increased by 11%, which is a more normal pattern, he said.

Looking to specific countries in Europe, he said, “Italy is struggling to emerge from a near-zero growth scenario. And the recent political events are not helping confidence.”

In January, the International Monetary Fund (IMF) cut Italy’s real GDP growth forecast for 2019 from 1% to 0.6%.

Further, ongoing tensions between Italy’s opposing political parties have taken a toll on the country, leading to potential debt troubles.

Still, the country’s largest bank, UniCredit, remains a “good example of opportunities emerging [in] Europe, even in the face of economic challenges,” said Valentini.

UniCredit is improving its return and driving efficiencies in the business, he said. “The plan that management has laid out is not dependent on the Italian macro or the European macro, but it’s self-help that management will deliver on, and that should lead to a re-rating of the stocks.”

Another example of a European company that is withstanding political and economic hardships is German automaker Volkswagen.

“After the dealer scandal, management focused on improving operating margins through reduced labour costs, introduced more disciplined CAPEX, [and] has improved the product mix to improve profit growth,” he said.

Global banks will outperform

The current market is divided between defensives and cyclicals, and this unique characteristic is most evident in financials, Valentini said. As a result, financials—specifically banks—are attractive after recent sell-offs.

“The valuation of UniCredit and Barclays are at levels close to those of the financial crisis or the Euro crisis of 2011,” he said.

And that’s why many investors may shy away from banks. “The market is looking at banks: banks were the problem the last time around, so they must be the problem this time.”

Valentini strongly disagrees. These banks have three times the capital they had before the crisis, and the loan books aren’t nearly as risk-loaded as 2007, he said.

“The higher-quality balance sheet, the better management and the higher ROE business is matched by a higher level of capital, and that should lead to outperformance as the real performance of the banks shines through.”

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