Despite growing economic concern, there is no shortage of reasons for optimism
In early 2014, there have seemed to be a few more areas of concern than we saw in late 2013. Namely, some questioning of the stability of the U.S. economic recovery, and of course, worries about prospects for emerging markets. That said, we are still finding plenty of reasons to be optimistic about the global equity outlook, and we are still finding values.
We feel confident enough in the U.S. economic recovery from the 2007-09 financial crisis that it almost sounds strange to us to still call it “recovery.” It feels pretty stable, considering the revival we've seen in the housing market, the improvement in household incomes, the deleveraging on the private sector side and the impressive amounts of cash U.S. corporations have on their balance sheets.
That being the case, U.S. valuations have come up and while we still like the United States, as value investors, we feel more strongly about European equities. European equity markets also performed well in 2013, but according to our analysis, Europe appears generally more compelling than the U.S. in terms of where earnings are, where margins are and the amount of catch-up European companies continue to do in relation to the United States.
We still feel that the most compelling opportunity set lies in Europe. We have been particularly interested in European financials on the equity side for a number of years, beginning at a time when it was considered quite contrarian. While not as inexpensive as they were a few years ago, we think there is still plenty of value in European financials, as some European banks are still trading below one times book value. The large French flagship bank BNP is one example of the kind of value we are seeing today. The company has rebuilt its capital base and has been paying back shareholders through dividends. Today, it has a sizable amount of excess capital on its balance sheet and has been bolstering holdings in existing subsidiaries throughout Europe.
Additionally, cash on balance sheets is generally high for many companies both inside and outside the U.S. and we think many companies may funnel some of that cash into technology. When we see heightened volatility in the economy overall, it can keep chief executives on the edge of their seats, hesitant to commit to spending. However, as we look at hardware, PCs and desktop technology are aging; the average age of equipment is quite high. While PC sales have fallen off a cliff due to sales of tablets and other devices, we have seen a lot of data to suggest that we should see some PC replacement coming through. And, as companies become more cloud-based, it should bode well for companies engaged in software and service.
We also continue to like pharmaceutical companies, which have re-rated to some degree over the past year or so — that is, awarded a higher earnings multiple — but still believe they do not fully reflect secular tail winds ahead such as aging demographics in many countries, the implementation of the Affordable Care Act and growing numbers of health care users in emerging markets. In some cases, we've been shifting our focus from large pharmaceutical stocks to biotechnology and health care equipment companies.
Lastly, energy is an area that's been fairly contrarian. Yet our analysis shows that oil service companies are being penalized for, and their valuations reflect, near-term supply and demand dynamics without consideration for numerous longer-term trends, which we believe could support sustained growth of oil services. More deep-water discoveries, the shale revolution and fracking, oil sands and the increasing importance of national oil companies all portend a higher concentration of oil services over time, in our view.
On the equity side, we continue to be enthusiastic about what we've seen in Europe. However, as emerging markets have come down over the past few months, we believe they could be the next pocket of opportunity as Europe turns the corner and its recovery matures. There are investors who are upset about what's happening in the emerging markets; naturally, investors want to see all markets go up at the same time. But we tend to be contrarians, so when we see markets pulling back, we roll up our sleeves in search of opportunities. However, we also believe it's critical to be stock pickers in emerging markets as not all fundamentals are equal. The markets are what we might call bifurcated, and so are the potential opportunities.
Lisa Myers is executive vice president of Templeton Global Equity Group and co-lead portfolio manager for Templeton Global Balanced Fund.
