Big value to be found in Europe’s big stocks

Europe has been fashionable with investors for some time, with the latest Merrill Lynch fund manager survey showing that a net 36 per cent are overweight European equities.

The rotation into Europe has been lopsided, however, and Morgan Stanley analysis indicates large-cap stocks are where investors should be looking to park their money.

Money has flowed into small and mid-sized stocks, the latter trading on a price-book ratio of more than two, compared to less than 1.5 for large-cap stocks.

In fact, relative to the overall market, large-cap stocks are trading at a 30-year low in terms of price-book valuations, and near 30-year lows in terms of relative dividend yields.

Adjusted price-earnings ratios are at record relative lows, some 30 per cent cheaper than the market – similar to the premium enjoyed by large-cap stocks in 2000 when they hit their structural peak.

Large-cap underperformance has persisted for years, but Morgan Stanley is encouraged by recent merger and acquisitions activity – most spectacularly in Pfizer's £63 billion (€77.3 billion) bid for AstraZeneca.

In short, the big guns will not stay "cheap and unloved" forever.


Bull market has room to run
There is one key takeaway from the above-mentioned Merrill Lynch monthly fund manager survey, namely that cash levels have jumped to the highest level since June 2012, indicating there is plenty of juice in the tank for further market gains.

Managers usually raise cash when spooked by equity declines, as was the case in June 2012.

Peculiarly, cash levels have remained high for some time, having been above 4.4 per cent – Merrill regards 4.5 per cent as a contrarian buy signal – for each of the last 11 months.

Today, they are at 5 per cent. A net 22 per cent of managers, meanwhile, are taking below-normal levels of risk.

Bull markets usually end when everybody is invested. That's not the case today.


AIB's daft share price is no joke
AIB bosses aren't chuffed to be running what is ostensibly one of the most valuable banks in the world, reminding investors last week that it now trades at eight times net asset value, eight times the European norm.

The State owns 99.8 per cent of the stock, and the tiny amount of shares available for trading has somehow resulted in a nutty valuation of about €59 billion. In Europe, only HSBC has a higher market value.

The ridiculous share price has been the butt of jokes for some time, although online comments indicate some investors remain unaware that the valuation makes no sense.

Shares have fallen by more than a third since March; naive investors need to realise that even AIB management is telling them a much bigger fall is coming.

Covestone's value bets pay off
Dublin-based wealth manager Covestone has enjoyed a fine start to 2014, with its Empiricus fund returning 10 per cent compared to just 1 per cent for global equities.

The move away from so-called "glamour stocks" has helped Covestone's value-driven approach, although chief investment officer Neil Osborne (pictured) says value stocks' recent outperformance is "not altogether unusual" – on average, the cheapest stocks beat the most expensive by 6 per cent annually.

So why, as Osborne puts it, do so many investors “systematically overvalue firms with exciting growth prospects and do the opposite for boring, value stocks”?

It’s a “lottery effect” – investors overpaying for the “small but vivid hope” of spectacular gains on high-flying growth stocks.

“Anomalies in markets don’t disappear because people know about them,” Osborne says.

“They only disappear when enough people do something about them and, given the emotional apparatus of the majority of investors, that challenge is a difficult one.”

Are you financially literate?
Stocktake readers are, hopefully, a financially literate bunch. A recent global survey, however, indicates most people are anything but.

The survey asked three basic questions. One: If you had €100 in a five-year savings account earning 2 per cent interest annually, would you end up with more than €102, exactly €102, or less than €102?

Two: Say you’re earning 1 per cent interest and inflation is running at 2 per cent per year. After a year, would you be able to buy more than today with your money, less with your money, or the same?

Three: Buying a single company stock usually provides a safer return than a stock fund. True or false?

Answers: more than €102; less buying power; false.

Only in Germany (53 per cent) and Switzerland (50 per cent) did more than half of people get each question right. Just 30 per cent did so in the US, 27 per cent in Japan, 25 per cent in Italy, and only 4 per cent in Russia.

The trickiest question, apparently, was the “stock or fund?” choice, indicating people just don’t get the benefits of diversification.