The Wall Street Journal-20080204-European Shares Tempting Some Buyers- Many Investors Are Betting the Likelihood of Recession Is Priced Into Stocks
Return to: The_Wall_Street_Journal-20080204
Full Text (725 words)
London -- As European stocks come off one of their steepest monthly losses in years, some see glimmers of opportunity emerging.
A growing number of analysts and investors believe that a U.S. recession and its likely impact on the European economy and corporate earnings is already reflected in stock prices and that select shares now offer compelling value.
Since the beginning of the year, stocks have been mauled over subprime-mortgage baggage and fears that the U.S., Europe's largest trading partner, will tip into recession. The pan-European Dow Jones Stoxx 600 Index, which rose 1.9% Friday, has slumped 9.9% this year and stands about 26% shy of its bull-market high of 400.31 struck on June 1. A bear market is traditionally defined as a 20% decline from a recent high.
"My gut feeling is that the balance of risk for equities is more to the upside than it is to the downside," said Mark Lovett, chief investment officer for U.K. and European equities at RCM.
Mr. Lovett said he has used the recent selloff to increase holdings in U.K. hedge-fund manager Man Group PLC and interdealer broker Tullett Prebon PLC -- both of which have been hit because of their tenuous links to the subprime-riddled financial sector.
Man Group shares have risen 2.5% this year, after chalking up a rise of 10% last year. Tullett Prebon stands 12% higher this year after losing 9% in 2007.
The cautious optimism in the market is founded on a number of factors, including a succession of interest-rate cuts by the U.S. Federal Reserve that could be matched by the Bank of England and perhaps, by midyear, by the European Central Bank. U.S. government officials have recognized the gravity of the risk to growth and also are hammering out a fiscal-stimulus plan. In addition, corporate balance sheets are in much better shape than in previous bear markets.
David Moss, who helps manage about 650 million euros, or roughly $960 million, in European stocks at F&C Asset Management, said the difference between this potential recession and the previous one, in 2001, is that this time it is being driven primarily by the U.S. consumer, while corporate balance sheets are strong. In 2001, the opposite was true.
Mr. Moss said he is focusing on companies that can grow by expanding sales financed by their own profits, rather than needing an economic upswing to drive growth. "We are also looking for companies with strong balance sheets, good, and/or rising, dividend yields and positive attitudes to shareholder remuneration," he added.
Mr. Moss finds construction stock Obrascon Huarte Lain SA and plasma-products manufacturer Grifols SA attractive. He also has picked up shares in Swiss engineering group ABB Ltd.
Obrascon's shares are down 3.2% this year after rising just 0.2% last year. Grifols shares are up 6.9% this year after rallying 53% in 2007. ABB, meanwhile, has lost 14% of its value this year after surging nearly 50% last year.
Joost Van Leenders, investment strategist at ABN Amro Asset Management in Amsterdam, isn't convinced that European markets have found a floor. Stocks could lose another 10% to 15%, he says. A U.S. recession would eventually prove a drag on the euro-zone economy and hurt companies that get a big share of earnings from the U.S., such as U.K. defense contractor BAE Systems PLC and Belgian supermarket chain Delhaize Group, whose brands include Food Lion.
Strategists at Societe Generale warn that a poor earnings outlook is likely to keep stocks under pressure. They say that although the Dow Jones Stoxx 600 index trades around 12 times forecast 2008 earnings, well below its average of 16, that is still too high.
"The evidence suggests that often major bear markets don't end until we end up at around 10 times earnings," they wrote in a recent report.
Some analysts contend that corporate earnings estimates don't yet truly reflect the threat that a U.S. and European slowdown -- let alone a recession -- pose. UBS strategists recently slashed their 2008 earnings forecast for Europe to zero growth from a 5% rise previously, with the risk that earnings could contract.
"The good news is the market tends to trough two months before earnings momentum turns," said Nick Nelson, a UBS strategist. "The bad news is we've only had three months of [consensus earnings] downgrades. Normal down cycles last for 10 months."
