The recent market selloff has bargain hunters shopping among U.S. stocks, but, for the real deals, you’ll need to look across the pond to Europe.
Stocks there trade at their biggest discount to U.S. stocks in years, thanks to exaggerated worries about populism that seems to portend a European Union breakup, trade wars and a growth slowdown.
Here’s more on the three big worries and why they might not be such a big deal, followed by a baker’s dozen of stocks that fund managers think are attractive.
The anti-elitist backlash in the U.S. is playing out in spades in Europe, too. We know this because of the continued rise in support for populist parties across the continent. That trend was confirmed in the late May when populist candidates scored big victories in the European Parliament elections last month.
But the risk that populists will bring down the European Union is smaller than it appears for a simple reason. Populists come from the far right and left on the political spectrum, and they are too far apart to ever form a coalition that scuttles the EU, now 28 nations, 19 of which have the euro as their common currency. “The influence of the populists is likely to remain limited because they are fragmented,” says J.P. Morgan analyst David Hensley,
Any changes are going to happen around the edges. “It is more about the nature of Europe rather than ripping it apart,” says Andrew Clifton, a portfolio specialist for T. Rowe Price European Equity strategy. “It is more a question about what kind of Europe people want.”
Europe — especially Germany — has a lot of exposure to China since it exports a lot of goods there. So worries about a U.S.-China trade war-induced slowdown in China spill over into Europe. Plus Tariff Man, or President Donald Trump, is also making noises about putting tariffs on European goods — particularly cars.
But Trump needs a strong U.S. economy and stock market to win the 2020 election. So he can only push these issues so far.
The growth slowdown
There’s no denying Europe is far weaker than the U.S. economy. U.S. GDP grew 2.9% last year compared with 1.8% in Europe. Goldman Sachs economists expect 2.4% growth for the U.S. this year, compared with 1.1% for Europe.
But there are some signs of improvement. Euro-area bank loan growth came in at 3.6% in April, which eased concerns that credit growth might be slowing. Consumers are generally in good shape. Eurozone fiscal stimulus in 2019 will be the highest since 2009, points out J.P. Morgan analyst Mislav Matejka.
Plus China pumped a lot of stimulus into its economy in the first quarter. Stimulus can take six months or more to kick in. As it does, this will help European growth, and lift sentiment toward European stocks. “Europe will benefit from that over the next three to six months,” says Clifton.
That remains to be seen, and the negatives on Europe are persuasive. So Europe is out of favor, compared with the U.S. “Investors have a hard time looking past that short-term declaration and thinking about the long term,” says Euro-bull Grady Burkett, a portfolio manager at the Diamond Hill Global Fund. This has lead to a valuation “overshoot,” he says.
To wit: The MSCI Europe Index is trading at a discount to the S&P 500 US:SPX that’s about as wide as it has ever been in the past 20 years. By now, many parts of the European stock look cheap relative to their expected growth rates.
• The Euro Stoxx 50 Index XX:SX5E , which tracks 50 eurozone blue-chips, recently traded at 13.4 times forward earnings, which are expected to grow 12.5% next year, according to Goldman Sachs.
• Germany’s Dax 30 DX:DAX was recently trading at 13.1 times forward earnings, which are expected to grow 13% next year.
• Spain’s IBEX 35 XX:IBEX recently traded at 11.3 times forward earnings, which are expected to grow 11.4%.
According to investor great Peter Lynch, stocks generally look attractive when they trade at a price/earnings-to-growth rate (PEG) ratio of one or less. The indexes above either fit the bill, or come pretty close. Here are some individual names that fund managers and analysts single out as particularly attractive.
European banks have been among the worst performers in the past year. That makes them some of the most attractive stocks now, according to J.P. Morgan, which recently upgraded its ratings on the group. Relative to the overall market, bank P/E ratios are around their historic lows. European banks recently traded at 0.7 times book value, a 58% discount to the market.
The good news is that European bank balance sheets are generally OK. And if global growth picks up because trade war fears calm down, the European economy and its banks will get a boost.
J.P. Morgan has overweight ratings on Partners Group US:PGPHF CH:PGHN , UBS US:UBS CH:UBSG and Allianz US:AZSEY DE:ALV XE:ALV . Clifton, at T. Rowe Price, highlights Zurich Insurance US:ZURVY CH:ZURN , a turnaround under new management.
Burkett at the Diamond Hill Global Fund thinks Anheuser-Busch InBev US:BUD BE:ABI looks “extremely attractive.” Investors are worried about sales-growth slowdowns in the U.S. and emerging markets more than Europe, but Burkett thinks those issues are more than priced in at current levels.
Clifton singles out the Swedish household products company Essity US:ESSYY SE:ESSITY , another turnaround. J.P. Morgan has overweight ratings on Nestlé US:NSRGY CH:NESN , Puma US:PUMSY DE:PUM XE:PUM and LVMH Moët Hennessy Louis Vuitton US:LVMUY FR:MC .
A specialty chemicals play
For a dive into the more obscure world of much smaller companies, consider Fuchs Petrolube US:FUPBY XE:FPE3 , another favorite of the Diamond Hill Global Fund’s Burkett. This is a chemical company that sells specialty lines of lubricants and various types of grease that are too small for big oil companies to bother with. “So it has a protected area of the market,” says Burkett.
The stock is down more than 50% since September in part because costs are rising. But Burkett thinks the company can pass higher costs along to customers. And it is working to boost margins by modernizing plants. Fuchs also has exposure to China — but that won’t be a problem if trade-war concerns ease, which is what I think is going to happen . The company pays a 1.8% dividend yield.
One advantage to owning European companies is that they tend to pay higher dividends than U.S. companies. “Most European investors are more income-centric and Americans are more growth centric,” says Mark Travis, CEO of the Intrepid Capital Funds, which offers a mutual fund called the Intrepid Capital Fund US:ICMBX . “So you tend to see higher dividends in European equities.” That’s a good thing in a yield-starved, low-interest-rate world.
Among well-known large-cap names paying decent dividends, T. Rowe Price’s Clifton highlights pharmaceutical firm Roche US:RHHBY CH:ROG , which has a strong position in cancer drugs and a solid pipeline of drug candidates. It pays a 3.3% yield.
He also likes Germany’s Berentzen-Gruppe US:BRTZF XE:BEZ , a schnapps company that has been around since the 1700s. Lately, it’s been modernizing its product line by introducing fruit-flavored spirits, which may juice growth. Travis thinks Berentzen-Gruppe is a potential buyout candidate.
Meanwhile, he says, the company’s dividend yield of over 4% beats the low yield on government debt instruments hands down. “I’d rather sell schnapps to the Germans and get a 4.1% dividend than a 2.5% yield from U.S. Treasurys. I know the Treasurys are never going to grow, but this company could.”
Also read: 8 U.K. stocks for contrarian U.S. investors
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested HD in his stock newsletter Brush Up on Stocks . Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist Group, and he attended Columbia Business School in the Knight-Bagehot program.