After what some have termed a “lost decade” economically, Europe now offers a potential bargain to investors willing to look through the political turmoil.
When the financial crisis hit, European markets fell to valuations cheaper than those in the US, and since then the American recovery has been stronger. The MSCI USA index has returned 82pc in five years in dollar terms, versus 28pc for the MSCI Europe index – in pounds it’s 135pc to 64pc.
This performance has driven up valuations of American stocks while Europe now looks comparatively cheap on the basis of its “Cape” score – a popular valuation metric that compares share prices with average earnings over 10 years.
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The US market has a Cape score (or “cyclically adjusted price to earnings ratio”) of 28, compared with 17 for developed European countries and eight for their less developed counterparts, according to Star Capital, a German investment firm.
Bill McQuaker, a multi-asset fund manager at Fidelity, said this disparity represented an anomaly relative to historic norms.
He said: “European performance relative to the US has now hit a 40-year low – the kind of level historically associated with strong corrections.
“But indicators show that the European economy is as strong as it has been since 2011 – some data says even since before the crisis.”
Recently, uncertainty regarding Brexit and the Dutch and French elections has put many investors off, despite the value on offer.
“People aren’t blind – it’s widely known that Europe is cheap – but until recently there had been little interest in European shares,” said Mr McQuaker.
He said political concerns were holding markets back, and if upsets in European elections weare avoided this year it could be the catalyst for improved performance.
The far-right populist candidate, Geert Wilders, failed to make headway in the Dutch election last week.
Martin Todd, manager of the Hermes European Alpha Equities fund, added: “All of last year we saw investors taking money out of European markets, the like of which we haven’t seen since the 2008 crisis. That demonstrates the sentiment towards Europe, and it pays to be greedy when others are afraid to invest.
“We’re past the danger of the European debt crisis, companies have grown earnings while cutting costs, and the MSCI Europe index is still below its pre-financial crisis peak.”
Top European funds
If European growth continues to recover, and the political risks fade, cheap, out-of-favour stocks that are sensitive to economic growth and interest rates will be likely beneficiaries.
Banks and financial stocks stand to benefit in particular. They have struggled since the financial crisis, as rock-bottom interest rates have limited the profit margins made on lending savers’ cash. Those margins expand when rates go up.
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Capital at risk
Mr McQuaker has a preference for European funds that hold cheap financial and other unfavoured stocks.
He tipped the £550m Invesco Perpetual European Equity Income fund, managed by Stephanie Butcher, which has returned 105pc over five years, against 63pc for the MSCI Europe index. Financial stocks account for more than 25pc of the fund.
It has a historic yield of 3.3pc and costs 0.89pc annually.
Andrew Summers, head of fund research at Investec Wealth & Investment, tipped Neptune’s European Opportunities fund.
The £300m fund has been run by Rob Burnett since 2005. Over three years it has struggled as a result of holding Italian banks, according to Mr Summers, but is the top- performing European fund over the past year, returning 49pc.
It has a heavy bias to banks, miners, chemical firms, industrial companies and other cheap stocks.
Crux European Special Situations, which has assets of £1.3bn, is another highly regarded European fund– it is regularly tipped by experts, including Mr McQuaker. It is managed by Richard Pease, who has decades of experience, and invests in companies he believes the market has undervalued.
It is in the top five funds in the Europe (excluding UK) sector for three and five year returns; it has returned 106pc over five years. The fund costs 0.86pc annually.
For “passive” investors who want specific exposure to financial stocks in Europe, the SPDR MSCI Europe Financials exchange-traded fund charges 0.3pc annually to track the MSCI Europe Financials index.
It uses a “physical” method to track the index, meaning it directly owns the underlying stocks.
The index includes large and mid-cap financial stocks across 15 of the most developed countries in Europe.
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