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Investors Eye Pockets of Value in Near-Record European Markets

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(Bloomberg) — With European stocks only just off record-highs, investors are having to look harder than ever to find pockets of value.

Companies that can absorb an inflation spike are in hot demand, while many think so-called value stocks are still cheap relative to growth, even after a huge rally. Others see upside potential in laggard sectors like energy and health care, while the U.K. is a focus for many following a period of underperformance versus its European counterparts.

A 13% advance in the Stoxx 600 Index so far this year has raised questions over how much of an expected post-pandemic recovery is already priced in. But with European firms set for a strong earnings rebound and the region’s stocks still trading at a steep discount to U.S. peers and offering attractive dividend yields, the foundations for further gains are in place. Identifying areas that have yet to fully reflect that potential will be key.

“European valuations, while expensive, are still more attractive than the U.S.,” Seema Shah, chief global strategist at Principal Global Investors, said by email. “For investors who are interested in the value trade, Europe is the place to focus given its very significant weighting of value.”

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Here are some of the areas where investors are looking for opportunities:

Price Cushions

Inflation, or rather, expected inflation, has been the theme of the year so far. Companies that have a sufficient buffer to absorb higher costs could fare best as the recovery progresses.

Guy Foster, chief strategist at Brewin Dolphin, says he likes inventory distributors that have a proven ability to pass on the costs of their inventory to customers. He cited Zara owner Inditex SA, whose shares have risen 17% year-to-date, and U.S.-focused construction supplier Ferguson Plc, up 12%.

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Value Still Value

So-called value, or cheaper, stocks is another pocket where investors see more upside as they have underperformed the rally in more economically sensitive cyclicals. While banks, autos and construction have outperformed this year on reopening bets, other value segments have lagged behind including insurance and energy, and parts of personal care.

“While it may seem as if value stocks have had a strong six months, they have merely begun to mend the devastating performance they have delivered to investors in recent years,” James Inglis-Jones, manager of Liontrust European Growth Fund, said by email.

Investors may look for firms that have beefed up their profit margins via cost cutting, said James Sym, head of European equities at River & Mercantile Group, citing the consumer sector as well as travel and leisure. Linen servicing firm Elis SA is a specific stock that may fall into that category, he said. Elis shares have risen 16% year-to-date, about in line with the market.

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Crude versus Miners

Miners have been among the stars of the stocks rally as optimism over an economic rebound, particularly in China, spurred demand for base metals like copper that are used to make everything from door fittings to electric wiring. Energy shares, on the other hand, may still offer catch-up potential.

“There’s a real risk that if we all start flying again at some point before the year end, people start travelling, that the oil price could certainly have a spike,” said Alan Custis, head of U.K. equities at Lazard Asset Management. Oil stocks could therefore start to look “incredibly cheap,” given the potential for capital to be returned to shareholders, Custis said in an interview.

Beyond Vaccines

The pandemic has made companies like AstraZeneca Plc, Pfizer Inc. and Moderna Inc. household names, thanks to their vaccine efforts. But pre-Covid-19, it was all about oncology: Astra, for example, spent many years transforming itself into a cancer treatment powerhouse.

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As the crisis eases, oncology could be a focus again. Astra and peer Roche Holding AG are among equities that are “cheap compared to their prospects of growth,” Luc Filip, head of investments at Syz Private Banking, said in an interview. The Stoxx 600 Health Care Index only just regained pre-pandemic levels, trailing the broader gauge’s advance of about 4%.

More broadly, health care may continue to benefit from the resumption of elective procedures that were held up by the pandemic, along with easing concerns around changes to U.S. pricing regulation due to the Democrats’ narrow control of Congress, according to Piergaetano Iaccarino, head of equity solutions at Amundi.

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Bargain Britain

While the U.K.’s vaccine rollout success has boosted its equities market, predictions of a quick economic rebound and higher interest rates have also pushed up the value of the pound. That’s cut the local-currency revenue from exports, leaving Britain’s stocks underperforming their European counterparts. The FTSE 100 Index is up just 8.6% this year compared with the 15% gain of the Euro Stoxx 50.

While underperformance appears to be purely driven by foreign exchange, Alain Zeitouni, head of multi-asset, EMEA at Russell Investments, says the U.K. remains “one of the most attractive equity markets worldwide.”

U.K. stocks offer some of the world’s highest dividend yields and the market can benefit from the nation’s economic recovery.

Europe

Meanwhile, Europe itself may be seen as a pocket of value by some. The Stoxx 600 Index has outperformed the S&P 500 this year, with the region coming back into favor among investors, but some see further gains ahead.

“We continue to promote Europe as a market poised to benefit from higher earnings growth, driven by the re-opening and the region’s pro-cyclical sector weighting,” Grace Peters, EMEA head of investment strategy at JPMorgan Private Bank, said by email. “We find attractive entry opportunities in European mining, construction, semiconductors and financials.”

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