In the first quarter of 2013, investors in European equities continued to behave like first time swimmers: they only wanted to enter the water wearing a life vest. Despite tentative signs of a global recovery, investors maintained a strong preference for “safe” global brand names in defensive sectors, says Ad van Tiggelen, Senior Investment Specialist at ING Investment Management…
As a result, prices of these stocks reached levels which evoked comparisons with the “nifty fifty” hype of the early seventies. One has to wonder: Have safe stocks become too expensive?
With Europe experiencing a prolonged period of economic stagnation and negative real interest rates, the love affair of investors with the Heinekens and Unilevers of this world is understandable. In a zero growth environment, any stock which combines (dividend) growth with a strong balance sheet, a global footprint and the ability to borrow money at ultra low yields, deserves a premium. The question is: how high should that premium be? At the moment, global brand names in food, beverage, household goods, pharma, technology and luxury goods demand valuation premiums of 20% to 60%, sometimes even higher.
In this sense comparisons can be made with the early seventies, when fifty US stocks which were seen as long term winners ultimately demanded price/earnings ratio’s of 40 or more, double the market valuation. They lost most of that premium afterwards and the “nifty fifty” experience was recorded in history books as an example of bubble blowing, just as the technology hype which followed in the late nineties. Having said this, I think that any comparison with the current situation is premature. The premiums now being paid for “safe” European stocks can still easily be justified, for the following reasons:
- Interest rates in the core of the eurozone are historically low and likely to remain so for the foreseeable future. This is a big difference with the inflationary seventies, when rates in the end eclipsed 10%. After all, growth is worth much more when discounted at low rates.
- Many of the current global brand names have a high exposure to emerging markets, which gives them a huge benefit in comparison with domestically focussed companies. This was different in the seventies, when the US and Europe themselves had emerging-market-characteristics and the iron curtain still existed. In those days, all western companies competed in the same market environment.
- In the seventies savers were well rewarded, certainly in nominal terms, offering a tempting alternative to equity investments. Nowadays savers find themselves in much less fortunate circumstances, inspiring some to also consider bonds or equities with a limited risk profile.
- Defensive global brand names have almost always traded at a premium against the broad market. Currently that premium is higher than average but still far removed from the 100%+ that historically counted as bubble territory.
All in all, I see sufficient reasons to believe that high profile growth stocks in Europe still have upside, despite their seemingly demanding valuations. Within this segment we have a preference for big pharma stocks, both in Europe and the US. This sector has, after a difficult period, entered a more benign product cycle and is expected to see its profits grow substantially over the coming years. With a valuation premium of less than 20% and dividend yields of 3% or more, it offers a nice life vest in choppy waters.