The Italian job and Eurozone investing

Euro trash or treasure? Europe's equities outlook.

Summary: Investors often view Europe as one investment zone, but in reality it has very different pockets.

Key take-out: Economic growth is increasing, but investors capital flows remain mixed.


As a place to invest, right now the Eurozone is hotly debated. 

There's concern around rising rates, political risks hanging overhead, and lingering uncertainty around Italy exiting the Eurozone in light of its populist coalition Government. 

But economic growth in the Eurozone is growing at its fastest pace in a decade, and by and large, European equities are more attractively valued than their US counterparts. This is making some investors look twice. 

Eyes on Italy

While some are looking twice, more are keeping a keen eye on Italy. 

AMP Capital chief economist Shane Oliver “must admit” he wasn't worried about last year's European political elections, but “the risks around Italy are greater”.

Populists have essentially taken over Italy, with the left-leaning Five Star Movement and far-right Northern League surprisingly forming a coalition. Large tax cuts, a basic income inclusion, and a roll back of pension reforms, are integral to the party's proposed policy and likely to cause a budget deficit blowout. Italian public debt is already around 130 per cent of GDP, the second-highest among Eurozone countries.

All this considered, Italian shares, which have been top performers in the last year, are now well down on the month. A little-known Italian prime minister designate was also appointed this week, the announcement sending shares further south. 

There is reason to cautiously approach Italian shares and bonds, but even after all the noise, resemblant of Greece a few years back, this could fizzle into a non-event. After all, French, Dutch and German elections recently took place without major incident. 

Oliver believes there are three reasons not to be concerned about an Italian exit from the Eurozone. 

He thinks it's unlikely to happen because the majority of Italians do support the euro, and support has actually risen from a year ago. As well, exiting the euro is easier said than done, as it involves currency redenomination, which would probably collapse the lira with disastrous knock-on effects. 

And even if the exit went ahead, he adds, “the risk of contagion” to the rest of the Eurozone is far less than it was earlier in the decade. Unemployment is lower overall, with vulnerable countries like Spain, Ireland, Portugal and Greece in much better shape now than before.

Europe ‘not expensive'

Eurozone shares are not expensive, historically speaking, and some investors prefer to focus on that fact alone.

Equities in the region are trading on a price to forward earnings multiple of 14-times, around the long-term average. On a Shiller price-earnings basis, they're a little more expensive at 17-times, but still nowhere close to the US at 32-times.

Plus, the European Central Bank is still pumping cash into the economy, unlike the US Federal Reserve, and a falling euro generally bodes well for offshore earners listed in Europe. 

That underscores the Morgan Stanley house view. The investment bank tips a 3 per cent return for US equities over the next 12 months, and 7 per cent for Europe. Morgan Stanley offers this:

“Europe remains our preferred equity region, and Japan our least preferred. A late-cycle market supports equity over fixed income still. We like positioning for late-cycle upside through equities and commodities.”

On a sectoral level, Morgan Stanley is favouring energy, finance and materials, and is underweight European pharmaceuticals, telecoms, automotive and retailers. 

Fund focus

Germany and France were the original powerhouses of the region, but now the periphery is starting to power up. At least, that's the view taken by various fund managers.

Catriona Burns, the lead fund manager at WAM Global, appears cautiously optimistic about the French market, based on Prime Minister Emmanuel Macron's efforts to implement labour reform. 

“But we are trying to identify companies that have their own runway of growth, that can do well, regardless of a European macro environment that is mixed,” she adds.

Platinum Asset Management's European fund is most exposed to Germany, followed by the UK, and trailed by Switzerland. Platinum added to its positions in the UK and Norway over the last quarter to March, as it slightly tapered positions in Germany and France. 

In one year, this Platinum fund has more than doubled in value, to $1.04 billion at the end of April. German companies account for around one-third of its top 10 positions. Most recently, Platinum has been shorting consumer staples in Sweden across several funds, recently closing a successful short position in popular fashion house H&M.

“The reality is that there are pockets of extreme exuberance mixed with pockets of exceptionally good value. We continue to uncover good investment ideas,” says Nik Dvornak, the fund's portfolio manager.

Meanwhile, Magellan has shifted some capital out of its global fund's US positions, including Facebook and Apple, as it takes on larger European positions. From December to March, the fund's exposure to Europe increased from 11.3 per cent to 15 per cent, while the US was drawn down a chunk, from 57.6 per cent to 45 per cent.

However, BlackRock, the world's biggest fund manager, says at the same time it has been observing more money flow out than into its European ETFs. 

In April, BlackRock's European equities saw outflows totalling $US5.7 billion, while its concentrated broad European and Eurozone funds saw outflows of $US4.8 billion, and German equities $US900 million. 

BlackRock tells InvestSMART that its European equity funds have lost $US11.5 billion in the last two months, the first sequential outflows since late 2016.

A caveat though. Of the entire Australian exchange traded products market, only 3 per cent is focused on Europe.

Ganesh Balendran, co-head of sales at ETF Securities, says Germany is still the powerhouse of the region, but the risk is the export-driven market “could become globally uncompetitive, a pain point of the Euro market, compared to a price competitive Asia”. Although, he adds, "people aren't exactly buying German products based on price". 

ETF Securities' European product saw $2.2 million flow out in April, after welcoming inflows of $6.6 million in March, $7.6 million in February, and $3.3 million in January. 

The bottom line

European markets, like the US, seems to be in a period of expansion. But it's difficult to pinpoint where they're all at in the cycle. Most say the US is late stage, and Europe a little (or a lot) earlier than that (depending who you ask). 

If you can stomach the risk of a domino effect — political spillovers in Italy causing problems throughout the region — then it might be worth considering investing in the Eurozone. 

Also, if you're brave enough to buck the outflows trend that fund managers are seeing through their own products.


The Intelligent Investor Equity Income Portfolio is now available as a listed fund trading under ASX code: INIF. Holdings in the Fund will mirror the Equity Income Portfolio, has the same low costs, but you can buy it on the ASX.

You can save yourself the broking by applying during the initial offer. Offer closes Friday, June 8, 2018.

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