Jacob Mitchell thinks a burgeoning economic recovery in Europe is being underappreciated by markets, particularly relative to the US, where investor enthusiasm about signs of global reflation were turbocharged by Donald Trump’s now-fading promises of dramatic fiscal stimulus.
The CIO of Antipodes Global Investment Partners also thinks investors have lost sight of relative valuations in emerging Asia where Korean equities and Hong Kong-listed China shares are offering great opportunities for value-conscious investors.
Almost two years after its inception in June 2015, his $2 billion Antipodes Global Fund — a high-conviction long-short value fund benchmarked to the MSCI All Country World Index in Australian dollars — has racked up a 24.3 per cent return after fees, beating the benchmark by 13.8 per cent.
Shares in the $342 million Antipodes Global Investment company — based on the global long-short fund — have risen from $1.10 to $1.20 since inception in October, sitting above net asset value.
But the environment hasn’t exactly been great for active fund managers. Despite the start of interest rate hikes by the US Federal Reserve in December 2015 and a rise in bond yields since last year, near record low rates globally have continued to dampen volatility and push up valuations for high-yield assets, even where their yields have fallen and risks have increased.
Indeed it’s been a challenge for active funds, but Mitchell feels that will change this year.
“In a rising market, if we are just marginally outperforming, then we will do better in a choppier market,” Mitchell tells The Australian in an exclusive interview.
“In a way, some people characterise the last 12 months as sort of a rebound in traditional value stocks, but I struggle with that analysis. Outside of iron ore and some of the direct exposures to the China rebound, the high multiples being paid for growth stocks remain intact. Until that breaks, I don’t think you can say there has been a proper rotation back to value.”
Central to his view is that there’s been a complete breakdown of the historical relationship between government bond yields and nominal economic growth, particularly in Europe. Despite all the focus on US economic prospects, the eurozone is actually doing very well and it isn’t reflected in markets.
“The eurozone bond market, probably because of the heightened concerns about the elections this year, is discounting a rapid deceleration in economic growth,” Mitchell says. “In contrast, if you look at the valuation of the US equity market, it’s forecasting an acceleration of economic growth.”
If the truth lies in between, there should be a convergence between US and European markets.
“US domestic-facing equities are priced for this relative perfection and those very low bond rates in Europe, I think, are impacting people’s savings.
“Let’s face it — the ECB has emergency-like policy settings, but the European economy is unequivocally recovering. It’s not as if we are talking about a European economy that’s showing any signs of fragility.”
Looking at the percentage of people employed versus the working age population — a measure that adjusts for changes in the labour-force participation rate, employment in Europe has recovered to its 2007 peak, whereas the US is still some way from pre-financial crisis levels.
“If we look at that domestic part of stockmarkets (services, communications, infrastructure, banks and insurance) that are ultimately sensitive to domestic economic conditions, there’s been a huge derating in most places against a huge rerating in the US,” Mitchell says.
That rerating in the US was happening before the election of Trump, and with Trump it accelerated on expectations of fiscal stimulus, which now look harder to achieve.
“What we’re observing with the Trump rally is that expectations around tax reform are already priced into a lot of these domestic beneficiaries in the US.
“This is where the discussion between the US and Europe gets quite interesting because we are starting to see momentum come out of the Trump trade. There is scope for a reality check over how much the President actually achieves, even with control of both houses of congress.”
At the same time, the international trade performance of the eurozone is surprisingly strong, and the rest of the world is benefiting from its surplus savings. Mitchell thinks the ECB is actually being far too slow to tighten interest rates. “When Germany is experiencing inflation of 1.5-2 per cent and German 10-year bunds are yielding 35 basis points, you have very loose monetary conditions in Northern Europe — Germany, Scandinavia and The Netherlands,” he says. “Germany is having a very un-German property cycle.”
In his view the ECB has to catch up, and when it starts to accelerate its tapering of bond purchases that are holding interest rates near record lows, it will be a positive for how a lot of the domestic-facing European equities are valued versus North American peers.
“I think that starts to close,” Mitchell says. “Those European equities are very cheap because low rates are creating these distortions and I think there’s a lot of misunderstanding around economic growth. It’s causing a severe crowding into factors like profitability. Investors have been willing to pay a high multiple for so-called ‘quality’-style companies. It’s almost been like a ‘quality’ bubble, but it’s more accurately a European and developed Asia quality bubble. What distinguishes those two regions? The lowest cash rates in the world — negative policy rates in Europe and until recently negative policy rates in Japan. That’s what’s driving this distortion.”
The overvaluation of profitability in Europe is most intensely expressed in the global defensives like healthcare and consumer stocks, whereas the domestic part of the market, particularly Western European banks, are extraordinarily cheap.
Some would say they are cheap for a reason, but Mitchell is more than happy to own ING, which isn’t exposed to the sovereign risks in Europe. The equivalent US bank would be Wells Fargo, but it’s trading on about 1.5 times tangible book value, whereas ING is trading on 1.0 times.
Telecom Italia is another standout for Mitchell. It trades on five times EBITDA, whereas Verizon in the US is arguably at the top of its profit cycle, yet the market is willing to pay seven times its EBITDA. European airlines also hold opportunities, with Deutsche Lufthansa trading as much as 50 per cent cheaper than Southwest Airlines in the US.
So what happens if we get through the French election without some huge shock?
“Even if (Marine) Le Pen got up, she will struggle to implement her platform,” Mitchell says. “The parliamentary election is what actually matters because it decides whether your president has any power. I think Le Pen seems to be a personality-driven party to say the least, and she doesn’t seem to have boots on the ground when it comes to the parliamentary resources to make a serious run.
“If you get through that, I just think you’re just set up for a serious reassessment of European opportunities because I think the ECB tightening policy would actually be positive for Europe.
“The valuations suggest Europe is cheap versus the US and China-exposed equities are cheap versus the rest of emerging markets. I think US investors are starting to realise the macroeconomic environment outside the US is not as bad as they thought.”