How to avoid euro ‘armageddon’

In Europe’s financial markets, the bears’ case is clear. Governments are suffocating under decades of debt and are on the verge of insolvency.

Investors have withdrawn their capital from the weak southern European countries and invested it in (supposedly) ‘safe’ countries, putting the existence of the euro in doubt.

European political leaders have exacerbated the crisis by failing to address its causes. Instead, they focus on its symptoms. “Extend and pretend” has been the politicians’ mantra for the past four years.

For the less pessimistically inclined, however, there are some positives. Spain has agreed to ringfence some of its more toxic loans. In time we should get the European Financial Stability Facility or the European Stability Mechanism (ESM) to take on this debt at a central level.

The detail is, as always, opaque, but it is a step in the right direction, even though the German constitutional court has delayed its preliminary ruling on the ESM. In addition, the European Central Bank (ECB) cut its deposit rate to zero, which has had the glorious effect of shifting €483bn (£379bn) to current accounts at the ECB because they are easier to maintain.

Furthermore, fund managers who invest in Europe are not buying GDP. Nor do fund managers need to have faith in deluded politicians to find attractive investment opportunities in Europe.

Companies cannot afford to be complacent. They have to adapt to changing conditions or lose. For example, Peugeot underestimated the lethargy of the European car market and did not sufficiently embrace the secular shift out of Europe and towards emerging markets. Its shareholders have paid a heavy price, with the share price declining by 85 per cent in the five years to the end of June 2012.

But in the European corporate landscape, poorly managed companies are the exception rather than the rule. Take Inditex, for example. At the beginning of 2007, nearly half its sales were coming from Spain and many top-down investors would have shunned the stock. This would have proved spectacularly wrong as the share has more than doubled in the past five years. The reason? Sales in Spain declined by close to 1 per cent a year, but sales outside Spain grew by 18 per cent a year. The Inditex group as a whole generated an annual compounded increase of sales of 11 per cent. The firm’s earnings per share grew at an even more impressive 14 per cent annual rate.

Including Inditex, we currently own six stocks with a Spanish ‘passport’, or 9 per cent of our fund’s net asset value. These companies have diversified their operations out of their distressed home market into emerging markets, mainly Latin America.