Much has been made of the fiscal difficulties that some European Union countries, most notably Greece, are experiencing. Less has been said about what opportunities may exist for investors interested in the countries in the EU. Dean Tenerelli, manager of the T. Rowe Price European Stock fund, says that there are many cheap opportunities in Europe. As a whole, he believes Europe is inviting for investors who are willing to look past some of the macroeconomic problems there. U.S. News caught up with Tenerelli to get his outlook for the region. Excerpts:
What opportunities do you see in Europe?
The first thing is that the market is cheap. ... You have to go back to the ‘90’s to see these [price-to-earnings] levels. The entire general market is very cheap. In general, Europe is benefiting from trends that other markets are seeing as well. Emerging markets continue to be strong, so European countries selling into emerging markets are getting a benefit from that. The U.S. is starting to recover, so European countries selling into the U.S. are seeing a benefit. The euro is weak. That helps exporters a bit. The general economy in Germany and northern Europe is stable-ish and will grow slightly this year, while southern Europe will have more of a problem but is bouncing along the bottom so it’s not worsening. As the economy normalizes, and as the growth starts to come back, I think there are good opportunities at the stock level to take advantage of the cheap valuations.
What kind of companies do you generally look for?
I generally invest in companies which have a high return on capital that are profitable businesses with well-defended business models that operate in consolidated markets where they have pricing power and give less negative surprises.
How does this investing climate compare with ones in the past?
It is [cheap], but that doesn’t come without its unknowns. The cheap comes with a caveat, which is there is great unknown on how quickly the economy will recover here. ... The austerity measures will hit in 2011. Most will not hit in 2010, so we haven’t seen it yet. The estimates that I’ve seen is between 3/4 to 1 percent of GDP being shaved off as a general rule, and that changes by county as well. There are countries that are more immune to that. I was in Germany a couple of weeks ago, and Germany feels quite OK. The good thing about Europe is that the consumer doesn’t have a lot of debt—when I talk about Europe as a whole—and certainly in Germany they don’t. The consumer spending is OK. Even if the austerity will hit through higher taxes or higher VAT rates, in general, the consumers have cash.
Your fund has a fairly large weighting in financial companies. Did last week’s stress tests make you more confident about the strength of European banks?
The stress tests were neutral to my confidence. For the stress tests, they were somewhat tough on GDP declines, but I think they could have done more on including more things under the stressing of the sovereign debt. So they stressed the sovereign debt, but there’s a good portion of the sovereign debt that didn’t take markdowns on the stress tests. To sum it up, the stress tests were sort of neutral to what I thought of the banks. One thing it did do is most of the banks provided increased disclosure on the sovereign bonds that they’re holding, which is key. So I think the information helps.
What about other developments?
Now, what’s happened today is there has been a cloud hanging over the banking sector, which is how much capital the banks are going to need as a result of the implementation of 'Basel 3', and they have substantially softened those requirements. No one really fully expected them to do 100 percent of what they’ve talked about. We didn’t know what they were going to be. Banks were less willing to lend because they knew had to save more capital because at some point Basel 3 would be implemented. Now that they’ve extended it to 2018—the implementation of Basel 3—and they also softened up some of the measures the banks will feel much more relaxed with as far as their ability to lend, and the amount of capital that they’re holding. This is important. Today’s move is more important [than the stress tests], and you can see it in the market. Some of the financials are up 10 percent as a result of this, while in the stress tests they didn’t really do anything. If Basil 3 was implemented in its purest form—and no one believed it was going to be—that would have required banks to continue to shore up capital and restricted their ability to lend. By changing it, the central banks have given the ability for banks to lend and not have to hoard capital anymore.
Do you think the cutbacks the Greek government is making go far enough?
They’re achieving a massive cut in government deficit to GDP this year. The amount they’re actually cutting in one year is phenomenal. It’s a big step. Don’t underestimate that. The IMF has come out and said, ‘They’re on track.’ ... So they are making progress by doing what they need to do. Now, the effect that this will have on the economy, we still have to see. So as far as investing in equities in Greece, I think it’s a tougher environment because we don’t really know the fallout. You’re really in the thick of the storms, in the thick of the cuts, and the cuts are dramatic. I don’t have any positions in Greece at the present. ... Maybe they’ll have to restructure their debt. They may. That will depend on how much growth slows down in the country. We have to see how the GDP reacts.
How do the EU’s debt problems compare with the fiscal situation in the U.S.?
The average government deficit figures are lower than in the U.S. when you look at the EU as an average. That still remains true. Consumer debt as a percentage of GDP is also lower in Europe than it is in the U.S. when you look at the EU as an average. The difference is that the EU, obviously, are different countries, so that in some countries it could be significantly higher, and that’s why you had the crisis in Greece and worries in Spain and Portugal. So in those specific countries the levels would be much higher than in the U.S., but in other countries like Germany, France, and Scandinavia they weigh you in the other direction. They’re much more balanced countries. The significant thing to keep in mind is that Europe is proceeding with austerity and will bring down their government deficit figures if all goes well pretty radically over the next couple of years, and the U.S. will be substantially higher.