Two portfolio managers discuss Europe’s progress in the recovery cycle and how currency and valuations shifts have created investment opportunities.
Matt Miller: Wesley, Europe: the macro outlook. What do you make of it now?
Wesley Phoa: Well, there’s a couple things to remember about Europe. The first is that economies go through these very long financial cycles — credit growth, deleveraging — and Europe is several years behind the United States. We got through our financial cycle five or six years ago. That was the bottom. We’ve been consolidating ever since then, and we’re in much better shape. Europe entered it much more recently, the consolidation phase. So it’s going through a painful deleveraging process, and it’s important to remember that that’s going on there; that won’t last forever.
The thing that we have to think about longer term in Europe is that structurally, it’s a lower growth economy than the United States just for demographic reasons. So their potential growth is significantly lower. But that said, it’s picking up. Europe in general, which was so troubled for the last few years, is really showing some more promising signs right now, and I think that is in part natural and in part due to some fairly important policy developments that have happened there over the past couple of years.
Matt Miller: So Gerald, then, within that broader context, how does Capital think about individual companies, opportunities, managements that can thrive or flourish in ways that our clients can benefit from?
Gerald Du Manoir: What you’re seeing is really almost a two-tier aspect of Europe. One tier, which is Germany continuing to be this machine of productivity and efficiency and great engineering and — whether it be in the auto-manufacturing areas, so BMW, Daimler, Volkswagen — being able to take advantage of the lower euro to be able to export their goods to non-European markets. Or then a second-tier part of Europe — which is, again, the peripheries, once they have restructured — are actually showing signs of recovery at the consumer level. So Ireland being a good example of that, Spain being another example of that, where, as I said, the banks, but also the retailers, are doing reasonably well.
In general, we try not to, again, think of an economy as an area where we allocate money to, but when a currency or cost of financing changes dramatically, that does change the fundamentals with which we analyze companies. Europe clearly has benefited from a lower euro, particularly relative to the dollar and the dollar-linked currencies, China being one of them. As a result, there are a lot of exporters that have restructured their balance sheets and restructured their cost base that are benefiting from their ability to compete and export to the growing market. So that’s how we think about it.
The second part of it is valuations. And to your early questions regarding the U.S. market, as Wesley pointed out, Europe was lagging in valuation — and actually quite dramatically at one point. It’s caught up. At Capital we tend to think of fundamental of company, quality of managements and valuations. And as such, we were quite interested in some of the European companies a year, year and a half ago as they were showing, like for like, much more attractive valuation. Things have adjusted.
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