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Does Political Risk Even Matter for European Stocks & ETFs?

From Tawhid Ali & Andrew Birse: With political uncertainty spreading across Europe, equity investors are feeling anxious. By focusing on companies that aren’t really exposed to regional instability, we think investors can discover resilient sources of return potential.

For investors seeking returns in Europe, equities present a conundrum. Compared with bond yields, which remain stuck near historic lows, stocks look very attractive. Yet equity markets also look vulnerable to a range of issues from a possible renewal of the Greek debt crisis to Brexit and the populist challenge in elections in several major countries.

Political risk cannot be ignored. But not every stock is affected in the same way. Some European companies, such as banks in countries with weaker sovereign debt, are highly sensitive to domestic politics. Many others are global players that benefit from positive trends around the world, but have stocks that trade at discounted prices in part because of the unsettled regional landscape.


It feels a little like 2012. At the time, Europe was engulfed in a sovereign-debt crisis that threatened to undermine the regional currency. Stocks looked scary. Yet there were plenty of attractively valued shares on offer at the time that simply weren’t affected by the surrounding events.

Take Ubisoft as an example. In 2012, shares of the French software games company were depressed amid concerns about delays for the next release of its popular Assassin’s Creed game franchise. Investors who studied the company at the time could determine that the delay would be temporary and global sales would be unaffected by concerns about the euro and French banks. Shares of Ubisoft rose more than sevenfold from 2012 through the end of 2016.

German robot manufacturer Kuka also emerged unscathed from the European crisis. At the time, investors were concerned that Kuka’s revenues from European carmakers would be hit by falling auto sales. In fact, the number of robots used to manufacture vehicles has steadily increased, driven by demand from China where companies are keen to combat rising labor costs and improve quality. Kuka’s stock has also surged since 2012.


What do these examples have to do with today’s markets? In both cases, investors who focused on companies and not countries could isolate individual business dynamics from external political and economic trends to gain conviction in an investment thesis. And in both cases, maintaining a long-term perspective—even when markets were fixated on short-term noise—was the decisive element.

Today, European stock markets offer abundant opportunities. European equities are attractively valued, in our view, at a price/forward earnings ratio of about 15x—an 8% discount to global developed stocks and a 17% discount to US stocks (Display, left). High-beta stocks, which are generally considered riskier, trade at very deep price/book discounts versus low-beta stocks. In other words, many investors are still overpaying for perceived safety, creating plentiful mispricing for stock pickers to exploit.


Take stocks in the European chemicals and energy industries, for example, which are attractively valued against global peers and their own history. In chemicals, some European players are well positioned to benefit from improving global supply and demand dynamics for specific products such as polyethelynes, used in plastics. Similarly, select European commodities groups might benefit as rebalancing supply and demand fuels price increases for products such as zinc sooner than expected.

In the energy sector, some oil majors are still attractively valued, even after the 2016 rally. Companies that cut costs dramatically during the oil price slump should enjoy more profitable business in the coming years. And don’t completely ignore domestic industries; select consumer companies have global brands and European exposure, which could do well if consumer spending continues to pick up.


Of course, an assessment of exposure to political risk must be factored into any investment decision. And in Europe, the potential for a highly market-disruptive event—such as a withdrawal of Italy from the euro—cannot be ruled out. But today, with so much policy uncertainty from Washington to Beijing, we believe the risks in Europe don’t warrant a greater political-risk discount.

Make no mistake. The news headlines coming out of Europe in the months ahead won’t always be easy to digest—and their consequences aren’t predictable, as seen in the market rallies following the Brexit vote and US elections. That said, investors can defuse short-term political risk by focusing on select companies that don’t depend on regional stability for their long-term success.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. AllianceBernstein Limited is authorized and regulated by the Financial Conduct Authority in the United Kingdom.

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

The Vanguard FTSE Europe ETF (NYSE:VGK) was trading at $49.65 per share on Monday afternoon, up $0.07 (+0.14%). Year-to-date, VGK has gained 3.57%, versus a 6.00% rise in the benchmark S&P 500 index during the same period.

VGK currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #2 of 91 ETFs in the European Equities ETFs category.

This article is brought to you courtesy of AllianceBernstein.

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