Valuations reign in Spain

The sovereign debt crisis brought an environment that challenged the fundamental investor to the limits

Dean Tenerelli

For a European equity stockpicker, it is hard to imagine a more challenging backdrop than the past five years.

While most equity markets have seen a sustained rise following the market lows after the global financial crisis, European stocks suffered sharp volatility at numerous points over the period as the debt-laden continent faced up to macroeconomic headwinds – particularly in the periphery. Markets even had to confront fears for the collapse of the EU’s single currency bloc.

This macro and political led climate threw up many challenges rarely considered for a fundamental investor but if you remained true to your investment process, it was possible to add alpha through this period.

I spend the majority of my time looking at company fundamentals and trying to determine future prospects. But through the sovereign debt crisis there were times when there was no liquidity, which brought many reasonable firms to the brink of failure. This was very similar to what we saw for many European governments as well. This was not an environment you are accustomed to as a fundamental investor.

At the same time, if you believed what the overall market was saying, there definitely was a real fear the eurozone could break up at some point. While it was an unlikely scenario in my mind, to truly serve our investors, we had to entertain the possibility.

What you did not want to do was make investment decisions based on central bank manoeuvring or political comments, as this was likely to lead the wrong way. What led our strategy to outperform over this period was to simply follow my usual investment process.

Trends

One of the areas our process lead to invest in was Spain. What we found in Spain during the sovereign debt turmoil was a market aggressively sold off, with earnings also extremely depressed. While the earnings situation was bad – earnings for some media firms were more than 50 per cent down from peak, for example – many stocks were still cheap, as unusual as that sounds.

After determining Spain was not going to leave the euro, we spent a lot of time over there and built up a large position in the country after noting valuation anomalies. We
took stakes in a number of names in media, regulated utilities and financials – which have all proved profitable.

Despite the bounce, Spain remains a significant relative overweight position but we actually recently took a position in Spanish property company Colonial. Spanish property prices are close to bottoming and we see a lot of upside. The UK is definitely the star performer of Europe this year and is likely to deliver 3 per cent GDP growth this year. Germany, the continent’s largest economy, is also doing well. 

Spain’s government has revised its growth expectations up from 1.2 to 1.5 per cent. Many of the forward indicators look strong for Spain, with employment creation now at multi year highs. There are still some areas of sluggishness, though, especially in France and Italy, where restructuring made during the crisis was minimal.

As the large reversion to European equities has already happened, it does look like a stockpicking market from now on. We are still finding compelling ideas. Probably the biggest unknown from here is how much of the earnings power actually returns for Europe after the crisis.

At the moment we are seeing some earnings downgrades but most of these are associated with the impact of emerging market demand and market currencies. The weakness in Asia and current strength of the euro and sterling is impacting on earnings for many companies with emerging market exposure but we are not seeing many downgrades for the domestic European plays.

Dean Tenerelli, manager of the T Rowe Price European Equity fund