Fri, 5 Oct 2012
The overall growth picture looks quite weak, but valuations of European stocks look compelling, says Morningstar OBSR's Peter Toogood.
Holly Cook: From Morningstar, I'm Holly Cook and today we're talking about international investing. I'm joined by Peter Toogood of Morningstar OBSR. Peter, thanks very much for joining me.
Peter Toogood: Hello.
Cook: So why don't we start off with a small question, what is the lay of the land in terms of the U.K. and Europe? What's going on in the macro level?
Toogood: OK, it's still very difficult. I think Europe has still got to deal with its issues in terms of recapitalizing its banks. It means that growth is relatively slow and moribund in half of the region in Europe: if you look at Germany and Sweden, you’d wonder if there’s a crisis; if you look at Italy and Spain, you’d think there’s something else [going on]. So treating it as one mass is problematic--a little like the U.S. and elsewhere: it's region by region.
So the overall growth picture looks quite weak, but there are huge pockets--I mean Germany is the largest economy in Europe, it's got the largest population and up until very recently it's been booming really, and has indeed got full employment. So it's not quite as simple as saying ‘[the outlook] is very poor’, but in aggregate it is difficult. Just taking the U.K. separately--similar issues of debt, more debt and still too much debt. So I’ll repeat the mantra ‘lower for longer in rates, and more than likely lower and longer in terms of growth’.
Cook: So we're coming towards the end of 2012 now, seems like not an awful lot has changed in the last nine to 12 months, but how about looking forward? What's your outlook like for the UK economy and for the eurozone?
Toogood: Well, I think we're in this stop-start process: they stimulate, they get some growth, it fails, they stimulate again, they do some more. You saw the U.K. Q3 numbers of strong growth, slightly a result of Q2 being relatively weak. So again, I think everyone’s looking for a secular trend where the theme is really deleveraging and it continues to be deleveraging. The U.S. is probably the most advanced through that process. If you look at Europe and the U.K., there is still a long way to go, certainly in Europe and one would argue in the U.K. as well. So from a sort of international perspective, outside the U.S., Europe is still fairly moribund.
Asia and the emerging markets are going through a cyclical downturn, this is not secular in their case, we suspect it’s more cyclical than secular. But they happen to be combining at once, which makes the world feel a little bit of a difficult place.
Cook: Of course, the economic outlook doesn’t necessarily convert into profits for companies… there isn’t necessarily a direct relationship, what’s corporate health looking like in these regions?
Toogood: It's the same as in the U.S. Again, the margins are relatively high, because labor costs are controlled, if you look at margins it is a function largely of cost control at a labor level. The labor share of GDP in the U.S. and elsewhere has been very muted for the last decade, really. Those benefits accrue to the profitability of the companies; they look solid because of that. Now in terms of valuations, in terms of relations to equities, you have to sort of look at the top line in a deleveraging world versus the profit margins and say: OK, profits continue to look better--though obviously they’ve stuttered to a halt more recently--but can that forever be at the expensive margins? Can margins stay high? And the answer is probably, in the medium term, no. And the other problem is revenue lines, so when are they going to start growing again in sort of a formative and more constructive fashion? And again you’d have to still say, we don't see that at this stage.
Not to be too bleak, but you have to recognize that the world is not the world of the last 30 years. People keep thinking it is. It's five years in to a deleveraging cycle, it's got further to go. It's not the end of the world, it's just slower, more painful and it's not as much fun.
Cook: And so if we just have a look at say the U.K. and Europe equities versus the US, do you think that one is looking more attractive than the other or is it really a bit of…
Toogood: On a valuation basis, there is no question that Europe and the US about three months ago reached extreme 30-year differential in valuations, you definitely wanted to be a pro-Europe. Because Europe isn't a region, it’s large amounts of companies, most of which international investors would recognize. Let’s take a simple example--BMW, or GlaxoSmithKline if you want to come to the U.K.--many very high-quality companies that are stuck in a regional basis because earnings are nothing to do with their domestic economies. So, [Europe] was relatively very cheap, it's still the better trade. There are U.S. investors in downward funds et cetera looking into Europe now on a valuation basis. [Europe] looks better value by some distance than in the U.S. at the moment, which is toward the higher end of its valuations range of the last decade, so in a relative sense Europe and U.K. look better.
Cook: Well Peter, thanks very much for giving us that overview. For Morningstar, I'm Holly Cook. Thanks for watching.