European equities have had a rough month, but Barclays analysts Ian Scott and Joao Toniato continue to recommend periphery stocks based on a combination of low valuations, rising confidence, and the ongoing Draghi put. They argue that current equity prices, especially in Spain and Italy, make sense when profits are low but haven’t priced in consensus growth.
Cheaper credit boosts consumer confidence in Spain, Italy
Spanish and Italian sovereign bond spreads have been falling against the 10-year Bund ever since ECB president Mario Draghi said he would do ‘whatever it takes’ to keep the eurozone intact in mid-2012, and they are now back to pre-euro crisis levels.
Cheaper credit has a big impact on consumer confidence in Italy and Spain because households tend to have both more assets and more debt than in other countries. Median household assets are €210,000 in Spain, €188,000 in Italy, and €67,900 in Germany. Spanish households have to spend nearly twice as much of their income servicing debt as a result, so the falling yields means they have more cash to spend elsewhere.
That doesn’t mean the lower rates will immediately trickle down to individuals, Scott and Toniato say that there tends to be a one-year lag between credit demand and loan growth, but the connection is still there.
European equities: Italian stocks trading at book value
“Equity markets seem to have adopted a ‘glass half empty’ approach to this collection of fundamentals. The Italian market in particular currently trades at book value, well below past valuation norms,” they write. “While the Spanish market is more fully valued on this basis – trading on a price / book multiple of 1.5, this is below the 2.1 times average multiple prevailing since the launch of the euro.”
Scott and Toniato recognize that the eurozone may not recover on schedule, but when companies are still trading at book value it means that investors have little to no confidence that profits are ever returning, even though analysts are becoming more bullish on both countries’ markets. From a value perspective, this is a great environment to start looking for stocks. If the market as a whole is trading at book value, or close to it in the case of Spain, there are bound to be companies trading for less. Now it’s a matter of finding the ones that survived the crisis in decent shape.