Pessimism on Europe: An opportunity For Value Investors?

Greece’s financial crisis began in 2009; this country was first bailed out last year with a €110 billion package, which proved insufficient. Now, an additional €120 billion plan is under discussion. The Greek government estimates that its debt could reach €350 billion by year’s end (about 150 percent of annual output). Some think that debt default or restructuring in the medium-term is inevitable (which is a technical form of default). The budget deficit is around 15.4 percent of GDP.


In order for the EU and IMF aid tranches to keep on flowing, the Greek government approved a five year austerity plan that includes: tax raises; cuts in spending, wages and benefits; and some privatizations. Protests are worsening and some have become violent.


But how did Greece get to this? The main culprits are: government corruption, bureaucracy, a bloated public sector and rampant tax evasion (Reuters with CNBC).


The longer this crisis drags on, the greater the probability of contagion. Ireland and Portugal have already been bailed out and there are worries on Spain (with a loan crisis and 20 percent unemployment) and Italy. Spain is a much larger economy than Greece and if needed, a bail out would be huge, so large that the European Central Bank, Germany and France might not even bother to try. It could be the end of the European Union.


About 70 percent of Greece’s debt is held abroad. The European Central Bank and some large German and French entities are amongst the lenders. A default by Greece could mire some of the banks, which in turn would require to be rescued, interbank loans could stop and then we would have a global financial crisis.


This is a gloomy scenario, isn’t it? Well, this is the kind of situation that some value investors love. In typical fashion of the panic stage in a financial crisis, companies all around Europe were dumped at

any price regardless of their quality. Should Europe based companies be shunned or embraced? Three fund managers and one finance and economics critic gave their opinion in a couple of CNBC interviews. These are some of their thoughts:


Sara H. Ketterer. Founder and CEO of Causeway Capital Management, LLC. An international investment management firm with $14 billion under management.

• A large percentage of the funds are invested in Europe, because Europe is on sale.

• Currently, European p/e multiples are lower than those in any other region in the world.

• European price to book values are as low as they have been since 2000.

• Dividend yields are higher than any other market.

• Notwithstanding the investors’ reluctance to invest in Europe. The quality is there and the values are there.

• Companies in Europe have entered some higher growth markets.

• Some of these companies are huge, like Siemens in Germany; over 30 percent of its revenues come from the emerging markets. Siemens is the largest foreign employer in China. A lot of growth has not been priced accurately.

• AkzoNobel in the Netherlands, is a huge global business in paints and coatings.

• They have some banks, only those with the highest quality, they like an Spanish and an Italian bank. Neither one has a significant exposure to Greece. They would like to have more, but the contagion effect is worrisome and there is still quite a bit to be resolved to decrease the risk levels in Europe. Yet banks are supplemented with the very large multi-national companies at extraordinary low valuations.

Theodore L. Parrish. Principal and Director of Investments at Henssler Asset Management, LLC.

• They are basically in U.S. companies.

• The companies that they own are multinational, so the revenues come from abroad.

• Next month surveys look pretty good for retail sales and manufacturing. Engineering and construction surveys have been positive. The declines in oil (19 percent) and gas (11 percent) prices will help the consumers to increase spending. The problem in housing is still there though.

• The U.S. is in a growth cycle and our companies are going to benefit from that.

• The valuations in the U.S. are not that much behind than those in Europe. But their growth rate is probably higher.

• They are trying to purchase stocks that will be able to pass along the higher expected inflation.

• They are in consumer staples where they think the U.S. companies dominate their global peers.

Charles “Chuck” de Lardemelle. Founding partner and portfolio manager of International Value Advisers, LLC (IVA). IVA has about $16 billion under management.

• The stocks that have come down are the product of speculation, specially the banks.

• There is a lot of guesswork on the ability of the politicians to fix up the situation.

• The high quality stocks, like Nestle, are barely 10 percent down from their high. Companies that do business outside of Europe, export a lot and have sound finances have hardly come down.

• The market does a good job at differentiating the good companies from those that are pure speculation.

• They are looking at some media stocks in Italy, Spain and France. They want small positions.

• They own some defensive stocks with high dividend yields, companies that do not need to borrow like: Vivendi and Total.

• They buy the stocks directly in Europe; if the ADR is liquid enough they buy the ADR.

• They have not bought European debt because the policies in those countries are very inconsistent.

Edward Harrison. Founder of Credit Writedowns a news and opinions site on finance, economics, markets and foreign policy. Mr. Harrison is a regular commentator on BBC World News, CNBC, Business News Network, and other.

• The thing we need to be worried about the situation in Europe is contagion, the potential for panic. Last week (from June 20 to June 26), money market funds in the U.S. experienced an outflow of $50 billion due to the exposure of the funds to banks in Europe, which in turn happened to be exposed to Greece. In the event of a default by Greece, it could lead to much more of this.

• There is a need to have a differential treatment between insolvent countries that require the principal or interest rate reduced and those that are capable to manage their problems. That is the case of Spain.

• The probability of a chain reaction has increased over time; Greece defaults, European banks holding Greek debt can not roll their paper, U.S. money market funds holding that paper then break the buck. This is a completely political situation, the European Central Bank and the European Union could get things under control but the will is not there. If you are an investor, you are goingto stay away from those debt issues because there is no certainty as to the political circumstances.

It is interesting to notice the dissimilar positions of Sarah Ketterer and Chuck de Lardemelle; while Ms. Ketterer stated that Europe is on sale with the lowest p/e ratios in the world even for the largest multi-national companies; Mr. de Lardemelle told that the best companies came down a mere 10 percent. Apparently, the two fund managers have been searching in different regions or maybe Ms. Ketterer has bothered to take a harder look and has even gazed under some rocks. Value investing has a very sound and simple principle, but nobody said it is easy to find and analyze opportunities.


Special care should be taken if the investor is thinking about buying shares in banks, financial companies and or debt issues with exposure on Greece (either directly or indirectly like the money market funds).


Readers must do their research and analysis and reach their OWN conclusions and decisions. All the contents on this article are for informational purposes only. If any reader decides to trade in stocks or any other investment vehicle agrees to do it at solely (his/her) own risk. None of the material presented here should be interpreted as a recommendation or solicitation to buy and or sale any security. The reader agrees to assume full responsibility for any and all gains and losses, financial, emotional or otherwise, experienced, suffered or incurred.


References:


Reuters with CNBC. "cnbc.com." 29 6 2011. A Quick Guide to the Greek

Financial Crisis. 7 2011 http://www.cnbc.com/id/43576577.


Ms. Ketterer and Mr. Parrish Interview


Mr. de Lardemelle and Mr. Harrison Interview