GLOBAL INVESTING: The bullish catalyst for French and Italian shares

Dubai - Europe has endured a lot, but there is still some optimism

Europe has now endured Brexit, Trump, the refugee tragedies, Putin's Ukraine war, a Greek sovereign debt spat, a failed Italian referendum, multiple banking crisis and the prospect of war in the Western Balkans just in 2016. Yet this week is also literally the 60th anniversary of the Treaty of Rome, one of the high points in human history.
Europe's Stoxx 600 index trades at 1.8 times book value and 14.9 times current earnings. This is not cheap but is relatively modest valuation given that Wall Street trades at three times book value and 18 times earnings. Of course, within Europe, there are vast variations in indices and sectors - Italy's MIB index, for instance, trades at book value. I believe that Emmanuel Macron, the centre-left independent candidate, will be the next president of France (though Martin Schultz could well be the next German chancellor), Europe's economic growth has begun to accelerate as PMI's are now in the 54-55 range and ECB President Mario Draghi could well engineer a steeper yield curve that will be a steroid shot for battered, unloved, underowned European banks. As global fund managers price out tail risks in Europe and bond yields normalise while the oil drop dampens inflation risk, the case for a valuation rerating in French and Italian equities becomes compelling. Of course, Italy's politics have been volatile and chaotic since the Florentine Renaissance (actually even much earlier - Caligula, Tiberius and Nero were not exactly exemplary pillars of governance). Political risk in Italy is an existential reality for investors, only the risk premium is now too richly priced.
Valuation alone is seldom a market timing indicator and, to me, never a go/no-go indicator. If I am wrong on the French election, all bets are off in European and global equities. Marine Le Pen is not priced into current risk premia and valuation metrics and world finance is not braced for Frexit. However, Europe's earnings growth cycle has begun to accelerate even as inflation and interest rates rise. This is nirvana for value stocks in the Old World (ex-Britain as Article 50 makes me allergic to UK equities and London property in 2017).
My conversational French is not fluent enough in Parisian slang to grasp all the nuances of the presidential debates but even I could tell that Macron outclassed Le Pen (a chubby bottle blonde housewife from La France Profonde!) and Fillon (a pseudo-Thatcher bureaucratic crook!) in all the key economic and financial issues de jour. This means I adore the très magnifique (0.65 times book value) rerating potential of the Banque Rouge et Noir, also known as Société Générale. This puppy trades at an unjustified 35 per cent discount to the European banking sector, has just appointed Lorenzo Bini Smaghi as chairman and offers a dividend yield of five per cent. Is the "Trump dump" reason to change my mind on SocGen? Mais non. The Volatility Index has not gone ballistic over 25. French money centre banks have fallen less than their US peers and emerging markets losses are less than the S&P 500 index. The intraday Volatility Index spike to 13.16 does not define a "vol get out" SOS to me. Not yet.
A French diplomat in the 1950s once said that "I love Germany so much that I am glad there are two of them". As a lifelong soccer fan, I do remember a world in which the Bonn Bundesrepublik and the Stalinist DDR coexisted, where Checkpoint Charlie divided the two worlds of Cold War Berlin. In times when GDP growth and inflation rises in Europe, high-beta German cyclical shares also outperform. This leads me to Daimler, Siemens, Deutsche Börse and Thyssenkrupp. Yet I concede that DAX at 12,000 makes German equities the most expensive major market in Europe. I see the risk reward calculus more in my favour in Italian equities priced at a mere book value. The best Italian country index fund I know is iShares MSCI Italy. Since I expect Milan's MIB to rise to 2,500 or at least 25 per cent in the next year right if the jokers in the Quirinale Palace get their act on bank bailouts/political reform right, I now love Bella Italia, the lovely peninsula whose national motto is Mamma, Pasta and Discoteca! If Macron wins the French election, Italian banks will be the macro trade de jour.
It is a cruel irony that Italy's GDP is still seven per cent below its 2007 pre-Lehman peak. After the failure of Matteo Renzi's referendum on political reform, I believe, nothing short of a landslide Cinque Stelle win (O Mamma Mia!) rules out the valuation rerating case for Milan.
The writer is a global equities strategist and fund manager.