Europe’s Cheap Stocks Set For A Long Catch-up Rally

Europe Stocks Little Changed as U.S. Shutdown Continues

The U.Ks FTSE 100 added 0.1 percent, Frances CAC 40 rose 0.9 percent and Germanys DAX increased 0.3 percent. Nokian Renkaat slumped 7.6 percent to 34.69 euros. Operating profit and net sales will fall this year from 2012, the company said in a statement today. That compares to an August prediction that sales and profit could increase in the full-year. Voestalpine slipped 2.3 percent to 34.67 euros in Vienna. Citigroup cut its recommendation to neutral from buy, saying the stock is expensive after rallying more than 50 percent since April 18. The brokerage also cut its rating on the European steel sector to underweight, similar to sell, saying hopes the industry will emerge from its current weakness are unfounded. Italian Gains Italys FTSE MIB (FTSEMIB) climbed 1.6 percent as a Senate panel recommended Silvio Berlusconis expulsion from the upper house because of his conviction for tax fraud . The recommendation must still be put before the Senate for a final vote. Banks led gains in Italy, with UniCredit SpA rising 3.4 percent to 5.23 euros, its highest price since December 2011, and Mediobanca SpA advancing 4.4 percent to 5.91 euros. Lindt (LISP) climbed 3.6 percent to 44,430 francs after the worlds largest premium chocolate maker said it will begin purchasing shares at the end of this month until the end of 2014, while maintaining its current dividend policy. Deutsche Lufthansa AG rose 2.1 percent to 14.41 euros.

In 2000 the gap between growth and value stocks was narrow yet the overall market downturn did not begin until around five months after the gap began to close. In the past five years the MSCI Europe Value Index has underperformed growth by nearly a quarter, in the run-up to the 2000 market peak, the gap between the two was less than 5 percentage points. SMALLER POOL In the current market rally – European stocks rose in 14 of the last 16 months and the STOXX Europe 600 index is up by around a third in that time, trading near five-year highs – the pool of obviously cheap, “deep value” stocks for investors to choose from has already contracted. The number of STOXX Europe 600 companies trading below their 10-year average price/earnings ratio has halved to around 270 over the past two years. On the flip side, investors’ aversion to companies exposed to the economic cycle during recent years has left many well-established companies with healthy balance sheets trading at lower valuations than the overall market. In these cases, the distinction between value and quality stocks has been blurred. “The opportunity is not so much in deep value but in relative valuation within the European equity space, where you have a lot of cheap cyclicals that you can invest in and benefit from the cyclical upturn,” said Manu Vandenbulck, senior investment manager at ING Investment Management. On a sector basis, energy and financials – the biggest weights within the MSCI Europe Value index – look the cheapest, followed by utilities and consumer discretionary shares. Investors, though, are using additional criteria to filter stocks that are cheap for good reason from those that may be unjustly discounted. ING Investment Management looks at sustainability of dividend payments, for example, while JPMorgan prefers firms well placed to ride Europe’s economic recovery. “That is banks, obviously, autos, part of construction, part of consumer cyclicals.