The disaster scenario in European shares
The biggest sword of Damocles over European equities is the risk of Russian military intervention in Ukraine to save the rebels of the self-styled ethnic Russian Donetsk People’s Republic.
The factory of German automotive parts Bosch in Rodez, France. The contraction in eurozone industrial production in July coincided with Berlin’s decision to agree to the White House’s ‘stage 3’ sanctions against the Kremlin. — AFP
European equities were collateral damage for escalation in the geopolitical tensions between the West and Russia over the civil war in eastern Ukraine. The pan-Europe 600 Stoxx index declined seven per cent and the German DAX fell by 1,000 points or 11 per cent in a mere two weeks in August. It is no coincidence that softer economic data across Europe, from Italy’s recession to Germany’s awful ZEW surveys, only amplified the gloom in Europe. Germany is the most high-beta, cyclical market in the Old World after Sweden, imports almost half its natural gas from Russia and is a major investor in East/Central Europe. Sanctions against the Kremlin raise the probability that Putin could well use his “gas weapon” against an economy that accounts for one-third of the European GDP and whose Bundesbank is the monetary anchor of the ECB and the Europe.
In fact, the contraction in eurozone industrial production in July coincided with Berlin’s decision to agree to the White House’s “stage 3” sanctions against the Kremlin and the widening of the Ukraine war as the Kiev government’s armies besiege rebel held Donetsk. This, of course, increases the risk of Russian military intervention in Ukraine. Are European equities cheap? Absolutely not. Europe traded at a post crisis high in mid-June and even now trades at 14 times earnings. The Banco Espirito Santo crisis in Portugal exposes the systemic black hole in European banking on the eve of the ECB stress test. It is not prudent to expect more than three to four per cent EPS growth in Europe, despite the lower euro and stellar results from insurers Swiss Life and Prudential.
The biggest sword of Damocles over European equities is the risk of Russian military intervention in Ukraine to save the rebels of the self-styled ethnic Russian Donetsk People’s Republic. This would be an economic catastrophe for both Russia and the EU and create havoc in trade relations, banking, energy and financial markets. Even ECB President Mario Draghi flagged Ukraine as a threat to Europe’s admittedly mediocre economic recovery. German equities, even after the correction, trade at 12 times earnings and are vulnerable to panic selling from offshore investors. It is impossible to handicap the next twist in the Ukraine war, though neither Berlin nor Moscow benefits from a protracted military conflict. If the current geopolitical stalemate continues, Switzerland is the natural, low-beta safe-haven market in Europe, thanks to the impact of megacap pharmaceuticals Novartis and Roche Holdings on the Swiss SMI. Switzerland trades at a premium to the Old World at 16 times earnings. I also believe Norway is one of the most undervalued stock markets in Europe, with the Olso OBX trading now at below 11 times forward earnings, thanks to the recent softness in Brent crude and global shipping indices.
My favourite German share remains luxury auto/truck manufacturer Daimler, which is on the eve of a new Mercedes-Benz product cycle, a €4 billion cost-cutting programme and a major recovery in the North American truck market. Daimler’s forward dividend yield is 4.8 per cent, more than four times the German Bund 10-year note yield. While I have avoided European banks like the plague since last March, when it was obvious that Washington would stiff BNP Paribas with a $9 billion fine to punish France’s largest money centre bank for dealing with Cuba, Iran and Sudan, I believe ING Amsterdam at €9 or Credit Suisse Zurch at €24 could present bottom fishing opportunities. In health care, Novo Nordisk in Denmark and Roche in Switzerland are global brand names in the insulin/diabetes and oncology markets. My technology horse in Europe is Germany’s SAP and industrial bet is France’s Schneider Electric. Biggest wild card index in Europe? Mamma Mia, no surprise Italy’s MIB index below 19,000!
Researched and compiled by Matein Khalid. Mr Khalid is a global equities strategist and fund manager. He can be contacted at: firstname.lastname@example.org
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