I’m not much of a golfer. Barry Norris is. So I drove up to The Gleneagles Hotel in Perthshire to interview him last week. After a rainy drive and a few loops round the car park trying to find a space not already occupied by a luxury SUV of one kind or another, I find him in the bar. It’s rather gloomy, which, given that we are about to spend an hour talking about Europe, seems appropriate.
Barry tends to have a bias towards optimism. That used to be pretty common among fund managers. It isn’t any more. So I start by wondering if his optimism is beginning to fail him too? It isn’t. When we think of the European economy, he says, we tend to think only of the bad things and forget the good. The good being that by far the most important economies in Europe are France and Germany – and both of those are growing “reasonably nicely”.
The other economies in Europe also aren’t quite as awful as the bears would have you believe. If you take out property – “which I know is a big issue to take out” – the economies of both Spain and Ireland are doing pretty well. Both have “very competitive export industries” already – even without any major devaluations.
And if you look back to the pre-crisis days before 2008, “the Spanish government and the Irish government hardly had any debt”. The fundamentals of their economies just aren’t as bad as people think.
What will save Europe?
Does he think that enough economies are strong enough for the euro to survive? He does. What needs to happen to make that happen? It would help if the European Central Bank (ECB) would loosen up a little. Every other bank around the world is pretty happy to monetise their debt – that’s why the Bank of England now owns a third of all the UK’s government debt.
But the ECB won’t. Clearly it isn’t easy for it to do so. There is the obvious problem – the Bundesbank’s fear of money printing. But there is also the secondary problem, which is that if the ECB starts buying sovereign debt it has to make political decisions about which country’s debt to monetise and therefore must “mess around in fiscal policy” along the way.
What about Eurobonds (bonds issued by and backed by the eurozone as a whole, rather than individual countries), the thing most commentators (including our own James Ferguson) insist are the way forward? Barry isn’t convinced. “My worry is that if Germany agrees to them it will eventually bankrupt itself” as its debt rises. “I can’t see how, without fiscal and political union, Germany can accept Eurobonds. It’s like giving everyone else your credit card and saying go out and spend.” It can’t happen in a “timeframe that the market might be happy about”.
Here comes America’s decade
Hmmm. So if we can’t get the ECB to print and Eurobonds aren’t the answer, what will save the eurozone? Barry reckons it is dollar/euro parity. He’s fairly convinced that the American recovery is “robust”. America’s property market “appears to be bottoming out”; its banks have done a good job of repairing their balance sheets; it is “making good loans with low leverage” and it has “political and economic institutions that the market has confidence in”.
We know that “if things get really tough the Fed will print money” – something that it has scope to do a good amount more of, given that so far it has only printed the equivalent of around 13% of GDP (we’ve done more like 25% in Britain).
The fact is that America is in an “incredibly privileged position where people have confidence in it and are willing to fund its deficit almost indefinitely”. Add in the shale gas boom, and the lower energy prices that this will bring, and America has both the time and the growth to work its way out of debt. “Who would have thought that ten-year Treasuries could yield 1.5% in a time of double-digit deficits?”
The point is that if the recovery in America is sustainable (and Barry thinks the next ten years will be “America’s decade”), then it makes sense for the euro to keep falling to parity – which, after all, was the rate when the euro was first launched.
Look at things through the prism of currencies and it makes sense that European growth has been so “anaemic” in the last 12 years. At one point the exchange rate was $1.60 – not a level where you’d expect much growth at all. But get it back to parity and Europe also has enough growth to work out of its debt.
The only problem, of course, is that this will be mildly inflationary for Germany (which is already seeing a rise in its money supply as savers remove their money from banks in the likes of Greece and Spain and redeposit it in Germany). However, at this point the Germans haven’t much of an option. If they won’t depreciate the euro via quantitative easing (QE), “the markets will probably do it for them”.
People are paying up for quality
How do we invest with this as our background? Think about what people will pay up for at the moment, says Barry. They’ll pay seemingly nutty prices for short-term German, Swiss and British debt or, indeed, for any asset they perceive as safe (check out London property prices). “So why wouldn’t the same thing happen on the stockmarket?” Why wouldn’t investors pay more than usual for “companies with good franchises, good growth and strong balance sheets”?
Stocks such as Nestlé (SIX: NESN)? I venture. “Nestlé, yes, exactly.” I say that most European fund managers I meet tell me that Nestlé is a top pick, and that the consensus is beginning to make me nervous. Barry says that the others might be saying they love Nestlé, but they aren’t buying it. Of the 105 funds in the sector, 35 don’t own any Nestlé. Of the remainly 70, only 20 have more than 5% in it.
Given that Nestlé makes up more than 5% of the index that most of these funds are benchmarked to, that means that the vast majority of them are “structurally underweight” the stock. They shouldn’t be. Right now, the thing to remember is that access to capital and balance-sheet strength are key. Stocks with these are most likely to weather the crisis. It is also worth remembering that falling commodity prices are going to mean they do “fantastically well on their margins”. They’ve been dealing with fast-rising commodity prices for a decade. Now they don’t have to anymore.
What to buy now
So would he recommend that we all pile into Europe now? Here Barry’s optimism really does begin to fail him a little. It looks cheap, he says, but it isn’t an automatic buy. If you don’t get any economic growth and profits fall across the board, then companies with a mixture of debt and equity could see the equity wiped out. It also probably makes sense if you are going to buy the stronger economies – “in a bad scenario, Germany will be bad but it will still be better than Spain”.
But in a good scenario (one with parity), “you’ll have a boom in Germany and that’ll be fantastic”. The time to buy the likes of Spain will come later, “if you get a convincing monetisation of debt along with Eurobonds”.
I ask about price. Our cover story last week pointed out that, on cyclically adjusted price/earnings ratios (CAPE), much of peripheral Europe is knocking around the levels that have historically suggested double-digit real returns over the following decade.
Barry accepts that, but he thinks now is a bit early to be getting particularly enthusiastic. Risky assets are “very, very cheap” all over the world and an awful lot of the bad news is priced in. But stocks with bad balance sheets in cyclical industries? Even if the “equity value of those stocks could go to zero”, they are still too risky. Add that to the extreme volatility in the market and the only way forward is really to be in a portfolio of very good-quality stocks with growth potential and to have “a medium to long-term perspective”.
I ask for his top stock tip. It’s Nestlé. I insist on another. He offers AstraZeneca (LSE: AZN), for the simple reason that it is cash-generative and cheap and debt free. It’s boring – and it certainly isn’t the kind of stock he would have imagined himself suggesting to us a decade ago – but if you want a safe haven from the eurozone crisis, it is probably one of the better places to find one.
Barry Norris
Barry Norris graduated from Cambridge in 1997, with a degree in international relations. Starting out as an investment analyst at Baillie Gifford, he went on to work at Neptune before leaving in 2005 to set up Argonaut Capital Partners with Oliver Russ.
Norris has been managing the Argonaut European Alpha fund since 2007. Free to invest in anything from small caps to giant companies all over Europe (excluding the UK), the fund is up 5.5% since launch. Not bad given the hammering the continent has taken – the benchmark is down 14.3% over the same period. And anyone who bought in three years ago would have done considerably better, with the fund up 34.3% since April 2009.
At present the fund is overweight northern Europe, with big holdings in Germany and Norway. He also manages the Argonaut European Absolute Return fund, which uses derivatives to take positions on falling or rising share prices. It’s up 17.5% since its February 2009 launch.