European debt deal to embolden stock value-hunters

European stocks are cheap compared with US peers and January's fund flows stateside are set to reverse if eurozone leaders succeed in their mission to end the regional debt crisis. The risk of a sovereign default, as measured by the Markit iTraxx SovX Western Europe credit default swap index, has lessened markedly since January, but that sentiment shift has yet to be reflected fully in European stocks, as markets await details of any deal.
Positive US economic data combined with the Federal Reserve's ultra-loose monetary policy have helped it attract cash from emerging markets and the eurozone in recent months, a Reuters poll on January asset allocations showed.
Those flows came around the time the SovX index hit a record wide of 222 basis points in early January, and although it has since come off 45 bps, moving funds to the United States then was an "easier choice", Karen Olney, UBS strategist, said. A March 24-25 gathering of European Union leaders will cap a series of meetings to flesh out a "comprehensive package" of measures to placate markets, which should tempt more investors back, Olney said. For some of those who shifted cash stateside, "Europe will be step two, and they'll start to spot the value. If the EU heads-of-state meetings lead to any tangible solutions, we would expect more money to be allocated to Europe," Olney said.
Index performance points to caution ahead of a final deal, with the MSCI Europe index lagging the MSCI US index by 12 percent since September 1, in local currency terms, Thomson Reuters DataStream data showed.
That caution has also been felt in the cash bond market, with the average 10-year government bond yield for Greece, Ireland, Portugal and Spain still high at around 8 percent, after rising from 4.5 percent to 8.5 percent in early January.
Last week, Portuguese 10-year yields hit a lifetime high on fears it would need a bailout. Stocks well placed to ride any fund flow reversal include French car parts supplier Valeo, French chemicals firm Arkema and UK-listed telecom BT Group, all of which are cheap based on Thomson Reuters StarMine data.
Valeo has a valuation-momentum (Val-Mo) score of 100, where 1 is weak and 100 is strong, and a relative valuation (Rel-Val) score, against all other stocks in the region, of 94. It has a predicted upside surprise on forward 12-months earnings per share of 5.8 percent and is trading 27 percent below its historical median forward 12-months price-earnings ratio. Arkema matches on the Val-Mo, has a predicted forward EPS surprise of 6.2 percent and is trading 32 percent below its 12-month historical median forward P/E ratio, as well as lagging the MSCI Europe by 1.8 percent over the last month.
BT, with a market cap of over $23 billion, is among the best placed large-caps, with a Val-Mo score of 99, a Rel-Val score of 97, has 4.3 percent predicted EPS upside surprise and trades 17 percent below its historical median forward 12-months P/E ratio. Further EU support for the weaker economies in Europe was "key", said Ian Scott, global head of equity strategy at Nomura, who is "neutral" on both US and European equities.
However, "we think the implications of the sovereign debt crisis have been exaggerated by the market, and I think as time goes on we'll see a further narrowing of sovereign spreads."
"We're starting to see exports from peripheral European economies responding quite strongly to demand from elsewhere in Europe and I think that's very positive, as it suggests the eurozone economy is more integrated than many people had thought." Fourth-quarter eurozone growth was 0.3 percent against 3.2 percent for the United States.
Societe Generale strategist Alain Bokobza, head of global asset allocation, advocated a "buy-the-rumour, sell-the-fact" trade ahead of end-March, citing peripheral eurozone index short covering as a sign the eurozone-collapse trade was over. While European stocks have performed well against US peers in the year-to-date, the gains have largely been fuelled by resurgent banks on valuation grounds after heavy losses in 2010, as the European Union acts to shore up confidence in the sector.
The MSCI European bank sector is up 12 percent in 2011 against a 5 percent gain for the wider index and a 6 percent rise for their US banking peers. While strong economic data, such as surging manufacturing and a fall in the jobless rate, had underpinned interest in US markets, Europe was not without its attractions. The sovereign debt issue aside, "if you close your eyes and imagine the euro area was one country, all these problems go away".