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The investment case for Europe and Japan

Anthony Fensom  |  07 Jun 2016Text size  Decrease  Increase  |  

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Australians love travelling to Europe and recently Japan, but with these economies recently stuck in low-growth mode, investors have tended to look elsewhere for overseas opportunities.

That attitude might need to change, at least according to some analysts.

In its latest "Global Economic Outlook" announced on 1 June, the OECD projected only modest growth for the Eurozone of 1.6 per cent this year and 1.7 per cent in 2017, with the world's biggest economic bloc hit by reduced exports to emerging economies along with the threat of "Brexit".

For Japan, the world's third-largest economy, the OECD forecast an even more modest 0.7 per cent GDP gain in 2016 and just 0.4 per cent next year on the back of weaker demand from Asia and sluggish private consumption, although next year's forecast reflected an anticipated hike in the consumption tax which Japanese Prime Minister Shinzo Abe now plans to postpone.

This compares to projected growth for the United States, the world's biggest economy, of 1.8 per cent this year and 2.2 per cent in 2017, while Australia's growth rate is seen strengthening towards 3 per cent by next year.

However, despite soft economic growth, both Europe and Japan offer attractive opportunities for diversified share investors, according to BetaShares chief economist David Bassanese.

"The United States has obviously had the stronger economic performance coming out of the GFC, with growth of around 2 to 2.5 per cent ... [but] the overall GDP performance of [Europe and Japan] doesn't tell the whole story, as growth related to their potential has been quite good, and earnings growth is looking good too as they focus more on shareholder value," he says.

Bassanese points to improved business investment and falling unemployment as beneficial factors, with both Europe and Japan benefitting from lower oil prices and stimulatory monetary policy.

In local currency terms, European shares have outperformed the S&P/ASX 200 since around December 2014, while also offering a superior dividend yield compared to US stocks despite their lower return on equity.

For diversification purposes, both markets are relatively underweight financials and resource stocks compared to the Australian bourse, offering investors more exposure to other sectors such as consumer, industrials and IT stocks.

European stocks also represent "reasonably good value" compared to their US counterparts, with the S&P Euro Index comprising around 90 per cent of an equity price to nominal GDP ratio compared to nearly 120 per cent for the US S&P 500.

Japan outperforms

Japan appears even less expensive, with the Japanese market's P/E ratio of around 12.3 times contrasting with the Australian bourse at 16 times.

According to Bassanese, Japanese stocks have comfortably outperformed the S&P/ASX 200 under "Abenomics," with earnings growth exceeding stock price growth since 2012 in contrast to the Australian, European and US markets.

In April 2016, the benchmark TOPIX Index of Tokyo stocks was at a one-year forward PE ratio of 12.9 times compared to its 10-year average of 19.8 times. This contrasted with the 17.1 times for Australian stocks, 17.6 for US stocks and 14.4 times for the S&P Euro.

While Japanese stocks' return on equity, dividend yield and net profit margin lag other markets, the pace of share buybacks and dividend payouts has increased in recent years as companies return more cash to shareholders.

Another positive for Japanese equities is buying by the Government Pension Investment Fund (GPIF), which with $1.7 trillion in assets has plenty of firepower to boost stocks as it increases its domestic equities allocation.

Meanwhile, the Bank of Japan has also been active in buying ETFs as part of its record-breaking quantitative easing policy.

"With the US having outperformed in the past few years, Europe and Japan appear attractive on a valuation basis as well as having some catch-up potential compared to US stocks," Bassanese says.

On 4 April, Nikko Asset Management described the US market as "overpriced," while maintaining a positive view on both European and Japanese equities.

It forecast an 11.1 per cent rise in the TOPIX in local currency terms through to September 2016, while predicting an 8.3 per cent gain in the MSCI Europe Index in euro terms over the same period.

Australian investors have an increasing variety of choices for international investments via exchange-traded products, as noted by Morningstar research analyst Alex Prineas, with Morningstar currently publishing qualitative analyst research for 49 Australian ETPs.

For Europe, current offerings include the BetaShares WisdomTree Europe ETF--Currency Hedged (HEUR), iShares Europe (IEU) and Vanguard FTSE Europe Shares (VEQ).

Japan-focused funds include the BetaShares WisdomTree Japan ETF--Currency Hedged (HJPN), iShares MSCI Japan (IJP) and the UBS IQ MSCI Japan Ethical (UBJ).

In April, Morningstar research analyst Wilson Wong described IJP as "a suitable choice for dedicated passive Japanese equities exposure" but "relatively expensive," with IEU also described as offering "a decent vehicle for passive European equity exposure," albeit also relatively costly.

But for investors seeking more international exposure, it appears timely to consider Europe and Japan as more than just attractive holiday destinations.

More from Morningstar

• A case for investing in infrastructure securities

• Australia's ETF boom to continue


Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.

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