Photo: Lars Plougmann on flickr
With several countries in Europe on the verge of default—most notably Greece, which has been downgraded twice by Moody’s Investors Service in less than a month—the continent may seem like a bad bet for investors, at first glance. But outside Portugal, Ireland, Italy, Greece, and Spain, countries often referred to as the PIIGS, there may be some bright spots for investors.
U.S. News recently spoke with Nichola Noriega, international equity strategist at Pittsburgh-based Federated Investors, about which areas of Europe currently offer the best investing opportunities. Excerpts:
What is the current outlook for investing in Europe?
We’ve been talking about the theme of divergence for probably a couple of years now. Clearly, there has been a lot of divergence between the developed markets and the emerging markets. But we’ve also been talking about the divergence within Europe, between the economies that we think are more global-facing with large export bases and then the economies that we felt were going to be mired in the high-debt, high-deficit issue for a while. This is something that we’ve been thinking about for quite some time. We’ve been focused on countries like Norway, Denmark, and Germany, countries that we think have high sovereign quality, both on an absolute and relative basis.
What do you mean by high-sovereign quality?
We look at a combination of things. We look at public debt-to-GDP. We look at budget balances and GDP. We also look at current account balances, trying to figure out essentially, is there cash coming in or cash coming out? How are exports growing? We also look at foreign currency reserves as a percentage of GDP. We look at all of these things together to look at the sovereign health of the economy. Those things have led us away from most of the peripheral economies.
Do you think the PIIGS designation is accurate?
Yes and no. Clearly, there are some similarities between them, but we see some distinctions amongst them as well. Clearly, Greece, Portugal, and Ireland are in a very troubled place right now. Greece and Portugal have very little exposure to the global economy, so they’re very reliant on what’s going on within their economies. It’s a more difficult position to dig yourself out of.
We see Italy as being very different. Certainly, debt is high there, but they own most of their debt, so they’re not as susceptible to [bond] spreads widening like in Greece, Portugal, or Ireland. So they’re in a very different position, in that they can fund themselves a lot more easily than some of these other economies, and therefore, it has less of an impact on their economy. When you look at the widening of [bond] spreads for countries like Spain and Italy, they’ve stayed pretty reasonable, even during the latest leg of the crisis where Greek spreads are widening significantly. Portuguese spreads are widening, and Irish spreads are rising. The market is starting to see some distinction between these economies, so we wouldn’t lump them all together.
What’s next for Greece?
We tend to think there is going to be some sort of a [debt] haircut coming. [There is] the Vienna plan. That may well be it. It may well be that they encourage the banks to roll over this debt and kick the can down the road a bit here. Clearly, the [European Central Bank] and the [European Union], for the matter, are very much against an official haircut, so we may well see a solution where some of these banks are going to be asked to roll over the debt over the medium term. I think that would be the least painful way for them to go. Again, it’s such a fluid situation, but that might be the most appetizing for the market.
What about the bright spots in Europe, such as Denmark and Norway?
They’re both relatively small markets. Everybody focuses on core Europe—Germany, France, and Spain—and I think the Scandinavian economies have not gotten as much air time. … They have a much lower correlation to the United States, so you get even more bang for your buck by being in them. We think they definitely are the bright spots for a variety of reasons. One, certainly, [is their] sovereign quality. The reason we think sovereign quality is important because it sets the environment for corporations to operate in.If you look at the UK, they have a very strong austerity program in place. When the government is cutting, it makes it difficult for companies to expand. I think if you’re in a healthier environment, it gives your companies and consumers some breathing room to take the weight from government and from government spending in order to get the recovering going or continuing. We think they’ve definitely benefited from being in strong sovereign positions. The governments were definitely able to stimulate the economy coming out of 2008 and early 2009 and kick-start the recovery. And that’s now being transitioned into more a private-sector recovery.
Explain your case for Norway.
The biggest thing that distinguishes the Norwegian economy is its exposure to energy. Clearly, that is in part why they barely went into a recession to begin with. [GDP fell by] about 1.5 per cent in 2009, and they came out of it pretty quickly as oil prices starting moving up again. Energy … is about 50 per cent of exports, so it’s a pretty significant part of the economy. … They have a budget surplus of around 10 per cent. That gives you a lot of wiggle room in terms of tackling any kind of a slowdown. They were able to pump a lot of money into the system. Their unemployment rate never rose significantly, certainly not to where ours did in the U.S., and their unemployment rate is back down to 3 or 4 per cent.
What other sectors stand out?
There are some materials companies like Yara, which is one of biggest holdings in the Federated InterContinental Fund (symbol RIMAX) in Norway. It’s a fertiliser company. They’re similar to Potash in Saskatchewan.
What about Denmark?
With Denmark, the story has definitely been a little different, probably because of the absence of the big contribution from energy. They had a very strong fiscal position, so the government was able to invest in the economy. They don’t run the kind of surplus that Norway does, but they have a deficit of around 2 to 3 per cent of GDP. So it’s a very low deficit to GDP compared to many of the other European economies. [It’s] not as stellar as Norway, but still pretty good. So they had money to invest in the economy. … One of the reasons we like Denmark is because of its export economy. They have shippers [and] pharmaceuticals companies like Nova Nordisk, which is one of the largest companies in our portfolio. It’s the largest manufacturer of insulin in the world.
What concerns do you have?
One of the things we are concerned about is valuation. The stocks have performed really well. Both Norway and Denmark have been among the biggest contributors to our performance, certainly this year. We’re starting to be a bit concerned about the valuations in Denmark, in particular.
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