Should Investors Look at Europe for Bargains?

Even before the U.K. voted to leave the European Union on June 23, European stock funds lagged U.S. large-capitalization returns and in the vote's aftermath, many European equity shares fell.

European shares have been under pressure for a few years now, along with other international investments, says Mitch Tuchman, managing director at Rebalance IRA in Palo Alto, California.

"They've been whacked by two things. The strengthening dollar has exacerbated the issue," he says. "Lagging economic growth outside the U.S. has also hurt."

Value investors sometimes watch for big events that may cause prices to drop further than justified when considering fundamental factors, but they're also cautious to avoid getting caught in a value trap -- that means losing sight of the reasons why an investment is cheap.

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Considering the ramifications of the U.K. Brexit vote, European market watchers have mixed opinions on whether the region is a buy. Those who are on the sidelines want the dust to settle regarding the vote, but others say there are selective ways to play European equities.

Aftershocks may continue. "Like after an earthquake, we believe the aftershocks from the 'Leave' vote will continue to reverberate through markets, the political economy and real economy -- in the U.K., the euro area and globally," Keith Parker, equity strategist for Barclays in New York, says in a late June research note.

The firm is cautious on equities as a whole globally, considering that the current economic growth backdrop is fragile, Parker says, pointing to a possibly slowing U.S. labor market and the lift from China's massive stimulus fading.

"Overall, we view the investment landscape from a 'prove it' perspective, in which risk premiums will be accrued to assets because the economic ramifications will take months to manifest," Parker says. "We think it is too soon to jump back into risk assets as the political developments that could move markets in coming weeks are skewed to the downside."

Nick Niziolek, head of international and global strategies and senior co-portfolio manager at Calamos in Naperville, Illinois, says Brexit is not seen as ushering in a global financial crisis or global recession, adding Calamos expects Germany will endeavor to hold members together.

Still, Niziolek says, expect price swings and uncertainty to continue going into earnings season. He adds although Calamos pared exposure both directly to U.K. and the eurozone more broadly, it hasn't exited the space.

Mark Heppenstall, chief investment officer of Penn Mutual Asset Management in Horsham, Pennsylvania, says even before the vote assessments were made on valuations not only in Europe, but globally.

"Given the valuations of European equities, relative to the valuation of U.S. equities, it's hard not to be more constructive purely based on valuation," he says.

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Yet, he also reminds investors they need to think about the potential for trouble in European equities. "I think you always face that risk of a value trap," he says.

Watching the credit markets. Heppenstall says he wants to take his clues from the European credit markets, which he says often lead the equities markets. The massive monetary policy accommodation by the European Central Bank with its bond-buying program and other actions has lowered ECB government yields and also lowered yields for European equities. Heppenstall says that's a positive sign.

Because of the Federal Reserve's quantitative-easing program and ultra-low interest rates, U.S. corporations were able to issue debt to finance equity-friendly behavior, such as share buybacks, paying higher dividends and fueling mergers and acquisitions, he says. This hasn't occurred in Europe much -- yet.

"We really haven't seen that type of activity get done across Europe. That can definitely be supportive of equity market performance, whether a company buys back its own shares or another buys another company's shares. You get that behavior and it's definitely supportive of valuations," Heppenstall says.

If the credit environment becomes tighter in Europe, "that would definitely make me more cautious," he adds.

Brian Beitner, manager of the Chautauqua Global Growth fund (ticker: CCGIX) and the Chautauqua International Growth Fund (CCWIX) for Baird in Boulder, Colorado, says slower economic growth means "European equity valuations are not as compelling as the relative underperformance would lead you to believe."

Investors should be choosy. Beitner says that means investors who want exposure to European equities need to be selective. For example, the firm favors European companies whose sales come outside the European borders, where economic growth is more robust.

"The opportunity to invest in Europe in our eyes comes from the notion that you have advantaged-companies that have world class management, world class IT, an educated workforce at their headquarters, (and) a very low cost to borrow," he says.

"When they tap into higher growth markets it's the best of both worlds."

Examples of companies using that strategy are pharmaceutical companies Novo Nordisk (NVO) and Roche Holdings, semiconductor firm Arm Holdings (ARMH) and Swiss bank Julius Baer, which Baird holds, Beitner says. These also are large-cap companies and market-share leaders in their segments.

Because of the European Central Bank's highly accommodative monetary policy, 10-year government bonds are around 0.14 percent, which makes financing easier, he says.

Some also have prestige as part of their brand.

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"Julius Baer is a pure-play Swiss private bank," Beitner says. "You have to be in Switzerland to be in a Swiss bank. There's a cachet to being a Swiss bank."

Debbie Carlson has more than 20 years experience as a journalist and has had bylines in Barron's, The Wall Street Journal, the Chicago Tribune, The Guardian, and other publications. Follow her on Twitter at @debbiecarlson1.