The eurozone is in deflation. The euro itself has weakened drastically over the past few years and it shows no sign of a recovery any time in the near future. With elections looming in Germany, Spain and the Netherlands, there may even be some political uncertainty over the next 12 months. So which areas can investors expand into outside the eurozone?
Outside of the monetary union of 19 states, Europe can easily be divided into two major economic areas excluding the UK and Switzerland –which recently saw its currency soar by 30 per cent after it removed its cap on the franc’s value against the euro. The Nordic countries – covering Norway, Sweden, Denmark and Iceland – and emerging European countries – which covers a vast area from the Czech Republic, Russia and Poland.
Chart 1 and Chart 2 look at the Organisation for Economic Co-operation and Development’s (OECD’s) projections for GDP growth and unemployment respectively, comparing the eurozone with Norway, Sweden, Turkey and Russia. While the eurozone has seen some of the lowest growth rates, unemployment rates have not been much better, currently standing at more than 11 per cent.
David Reid, co-manager of the BlackRock Emerging Europe investment trust, says emerging Europe is an area that offers something different to mainstream Europe. “One thing that is very clear is value. If you take the MSCI index as a basis, emerging Europe trades at less than 6x p/e, while Europe trades at 12.5x. So for every pound you invest in emerging Europe, you are getting twice as much earnings for your money than you do in developed markets.”
He says it is not just about earnings, but dividends are also important to consider. “The dividend yield in emerging Europe is now 4.7 per cent, which is really quite appreciable and nice to have.”
Let it grow
Another area to consider is growth. Mr Reid says, “We are in a situation now where you look at the European Union countries and they are growing by less than 1 per cent in real terms, but compare that with somewhere like Hungary – which last year grew the fastest it has done since 2006 – at 2.2 per cent, and Romania which is growing around 3.5 per cent.”
“What is important looking at equities is the potential growth. These are long-term investments and most of the countries have a long way to go until they converge with Europe so you can expect them to be growing more quickly as a result of all the competitive advantages they have,” he adds.
Opportunities in Turkey
Looking back at January 2014, Mr Reid says he bought heavily into Turkey, while it was still an unfavourable market. “People were very much worrying about the ‘fragile five’ [Brazil, South Africa, Indonesia, India and Turkey] and rising interest rates globally. Now it has gone in the other direction over the course of 2014, but there was a lot of panic at that time. It was somewhere quite interesting because typically, when other people are panicking, there’s an opportunity for investors who know these markets. So we invested quite heavily there and that worked very well for us.”
Turkey has been a popular investment with many fund managers. Kanwal Masood, portfolio specialist at T. Rowe. Price, says, “Turkey is one country we like from both a macro perspective and from a bottom-up view. There are also opportunities in countries such as Kazakhstan and Georgia, in particular in the banking sectors. Another market that is interesting but challenging is Russia. We have a bulk of our portfolio invested in Russia despite the macroeconomic or price worries. There are still opportunities on a medium- to long-term view.”
While Turkey is not a high growth country, she says the demographics make up for that and are very attractive. “It has a solid banking system, and one of the key advantages of Turkey is it has had structural reform over time. It’s right at the macro level, but there are two areas of concern. The current account deficit and political uncertainty after the election that took place.”
She says Halk Bankasi and Garanti Bankasi are two “extremely well run” examples of banks with potential – each provides loans to emerging markets. Banks, she adds, are still benefiting from under-penetration.
The election in Turkey saw Recep Tayyip Erdoğan become president after being prime minister for 13 years. Ms Masood says while the initial uncertainty has passed, the economy should improve because it is a net importer of oil.
Sanctions
Away from Turkey, there are other emerging economies within Europe. Last year, Russia dominated headlines for many reasons – from its recession to the annexation of Crimea, prompting sanctions against individuals and businesses from Russia and Ukraine. Both the US and EU published lists of companies and people who were hit with travel bans and had their assets frozen.
Russia is one country Ms Masood believes has been particularly “messy”, although she is still finding stock opportunities. “It has been an interesting one for us,” she says. “It was a huge underperformer in 2014, a lot of stocks have been big across the board. But we continue to maintain exposure there. We have been cautious on adding to stocks. I think the near-term risks will persist for a while.”
Some key risks of investing in Russia include the aforementioned recession – exacerbated by the sanctions from the west – which has been impacting growth, and the low oil price. Ms Masood points to the price of oil as being a reason why prospects are low for the country. “From a top-down perspective, it looks really messy.”
“Magnit is an example of a company where despite the slowdown in 2014 it has growth earnings of 24 per cent, maintains high growth levels and managed to keep market share from competitors,” she says. The food retailer is a company that was able to maintain growth, she adds.
Russian equities are an area that Ms Masood believes has attractive valuations, but one she has been gradually trimming. “We had a significantly overweight position, and while we are still overweight, it was still much smaller than it was three months ago.”
BlackRock’s Mr Reid has also been taking money out of Russia. He says, “That was partly due to the Ukraine conflict but also – and significantly – because we had concerns about the growth model in Russia. We expected oil prices to come down. Russia has not been a particularly good place to be.”
Scandinavia
But emerging Europe is not the only opportunity for investment outside the eurozone. Hermes Sourcecap invests heavily in the Nordic regions, maximising on its growth levels. Andrew Parry, head of equities at Hermes Investment, says when it comes to the Nordic countries, it is very much about investing in stocks and sectors rather than looking at the specific countries.
“In the Nordics we have a lot of allocation to the banking sector. Swedbank and DNB are well funded banks in rehabilitation of their balance sheets and have continued to be attractive.”
Swedbank currently trades on a p/e ratio of 12x earnings, while DNB Nord, Norway’s largest financial services group, trades at 8x. He says there is a lot of flexibility in the Nordic banks, but they are not as cheap as they used to be. Healthcare is very attractive thanks to demographics pointing towards an ageing population and technology playing a big part, which is seeing rapid innovations, he says. “The Nordics are in in a triple zero economy. Where there is no growth, no inflation and a 0 per cent interest rate.”
Mr Parry says the key for non-eurozone European countries is to follow the growth. “Everyone says the US is expensive. But why is it expensive? Because it is growing.”
Growth in the eurozone is particularly low. As seen in Chart 1, countries such as the Nordics and Turkey have greater growth prospects – for example, the OECD is forecasting 4 per cent growth in Turkey by 2016. Although there are not many funds available specifically for non-eurozone countries, many funds have holdings in major Nordic or emerging European stocks.
Looking outside the eurozone could be a way of accessing multinational companies without having the issues of the euro behind them. While investment in the monetary bloc may be lacklustre now, there are clearly opportunities elsewhere.