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Betting on beaten down European equities

Cheap valuations and earnings growth could be a catalyst for Europe this year, according to Ferdinand Cheuk, portfolio manager for global equities at Franklin Templeton Investments.
Ferdinand Cheuk, Franklin Templeton Investments

A number of investment professionals, including those from Blackrock and Schroders, have preferred US or emerging market equities over Europe amid rising political risks, such as Brexit and the rising populism in the region.

Similarly, Stephen Tong, Hong Kong-based client portfolio manager for multi-asset solutions at Franklin Templeton Investments shared the same sentiment during a recent client event in Hong Kong last week.

“Brexit and the rising populism in countries like Italy and Europe are going to change how the markets in the EU interact with one another. That is something we are worrying about, so we are underweighting both the UK and European equity markets,” Tong said.

European markets were largely down last year. The MSCI AC Europe Index fell 14.22% in 2018, which is lower than the MSCI AC World Index’ -8.93% performance, according to data from FE Analytics.

However, one of Tong’s colleagues, speaking at the event, provided a different view of European equities.

Ferdinand Cheuk, portfolio manager for global equities at Franklin Templeton, acknowledged that US equities outperformed most of the major equity markets globally.

“The US market was down 6% last year, whereas the other major markets were down between 10-20%,” he said.

However, valuations in other markets, particularly in Europe, have gone down significantly as well.

“The world is trading at a price-to-earnings ratio of 22x, whereas the US is 27x. Europe is relatively cheap, at 15x, which is a very good starting point for the region,” Cheuk said.

Cheuk added that European companies historically contribute around 35% of the world’s global earnings, which has gone down to 25%.

He believes Europe’s share of global earnings will return  to historical levels as company earnings in the region increase.

Fourth quarter earnings of the Euro Stoxx 600 Index is expected to rise to 6% from the previous year, according to data from Thomson Reuters.

“We believe that earnings growth coupled with cheap valuations make a good story for European equities,” Cheuk said.

One of the firm’s global equity funds, the Templeton Global Fund, has at least 36% of its assets in European equities, including the UK, according to the fund factsheet. The fund is underweight the US (25.39%) relative to its benchmark index, the MSCI AC World Index (54.41%).

Value comeback?

Cheuk also believes that value stocks are making a comeback.

“The normalising rate environment will provide a very good backdrop for stock pickers to select value stocks.

“Value has been underperforming growth for some time. But we are hoping that this is going to end, as we have seen value has been performing better during the second half of last year,” he said.

The FTSE Developed Growth Index outperformed its value index counterpart last year, according to data from FE. However, the gap of their performance has closed during the second half of the year.

Source: FE Analytics. In US dollars.

The Templeton Global Fund versus its benchmark index.

Source: FE Analytics. Note: All fund and index NAVs have been converted to US dollars

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