European markets have taken a pounding due to worries of a global recession and deepening anxiety over a banking crisis that requires government bailouts. Yet, in the midst of the gloom, fund managers see an opportunity to load up on battered stocks.

In hindsight, some money managers argue, the crash was unsurprising.

“It’s always the same thing,” says Ian Scullion, lead manager of CIBC European Equity Fund and vice president and head of the EAFE team in Montreal with CIBC Global Asset Management Inc. “When the market goes up, everybody gets excited. When it goes down, everybody panics. The pendulum goes up big time, but it doesn’t stop at the mean. It will go way back, and then revert to the mean. But we’re not there yet.”

Scullion expects more bad news to emerge: “The world is hurting.”

As an example, he points to General Electric Co. raising US$3 billion by selling preferred shares to American investing guru Warren Buffett.

“I’ve been telling financial services management teams for the past two years: ‘You do not control the leverage you have, versus all the funky, toxic derivative products that you are selling. This will unfold, because you do not control the risk’,” Scullion says. “They could not convince us how they would manage this huge securitization, such as subprime mortgages in the U.S.”

Given the depth of the problems, Scullion believes that the market correction is reminiscent of the U.S. savings and loans crisis in the late 1980s and the bursting of the 2000-01 tech bubble. “Every bull market is the same,” he says. “We’re always dealing with excesses.”

From Scullion’s perspective, however, many European companies are only marginally affected and are ripe for the picking. “The Nestlés and Tescos of the world are very slightly affected by what’s happening,” he says, “because they have very strong balance sheets and don’t need any financing. But their stocks are being pulled down by this panic.

“Companies that were trading at prices that are 40%-50% higher than today are now at bargain prices,” he adds. “We love it, and are increasing our existing stakes.”

A bottom-up growth investor with a defensive bias, Scullion is running a 45-name portfolio in the CIBC fund that favours large-cap companies that are industry leaders.

Regardless of sector or country, Scullion selects stocks based on four basic criteria: companies must demonstrate sustainable growth; benefit from barriers to entry; management must have a proven track record; valuation is the fourth criterion, and Scullion looks for companies with strong free cash flow.

“If the top-line growth is sustainable, profitability will be sustainable through time. If companies have the luxury to increase prices, they can protect their margins,” says Scullion, adding that he is shunning cyclical stocks, especially resources plays, as they don’t fit his criteria.

One top holding is Essilor International SA. One of the world’s largest makers of prescription lenses, the French firm generates about 10 billion euros a year in revenue. “It’s one of the best examples in the portfolio,” says Scullion, “in terms of top-line and bottom-line sustainability.”

Essilor is growing its top line by about 6%-7% a year, he says, and its bottom line by 10%-14%. A long-time holding, it recently traded at 29 euros a share, down from 45 euros a share a year ago. Scullion has no stated target, although the current share price looks attractive.

Another favourite is Vestas Wind Systems Ltd. The Copenhagen-based firm is one of the leading manufacturers of wind-generated turbine systems.

“Every metric and variable suggests this is a sustainable growth industry over the next 10-15 years,” Scullion says, noting that several European countries, including Germany, are setting high targets for renewable energy in the next decade. “There is huge potential.”

The stock recently traded at 290 Danish kroner a share, down from its high of 700 DKK set this past June, when Scullion reduced the CIBC fund’s exposure. “[The stock] pulled back, like we thought,” he says. “We will be able to add to the position eventually.”



Although buying opportunities are definitely cropping up, the market turmoil may continue for some time, says Martin Fahey, manager of Investors European Equity Fund and head of European equities with Dublin-based I.G. Investment Management Ltd.

“Markets are down by 42% from the peak a year ago. So, it’s a buying opportunity. Having said that, markets will continue to be very volatile,” says Fahey. “Despite the moves by the central banks and concerted action by Britain and U.S. authorities, I am not saying we have hit the lows. That might be ahead of us yet.”

@page_break@European markets previously bottomed in 2003, he adds, after falling by 62%.

“People look at the average correction in the past — which was 28%-30%. But the period we are in now is abnormal,” says Fahey. “The scale of the problems is quite substantial. It’s not something that can be fixed in six months. It could take years for economies to turn around. But markets could bottom by yearend. The rate at which markets have fallen daily is so dramatic that it tells me we are closer to the end.”

Today’s markets are different from those that corrected in 2000-03, explains Fahey. Back then, stocks traded at price/earnings multiples of about 25, and fell to around 15 times. This time, multiples have fallen from 12 times earnings to around eight or nine.

“We have come into this correction cheaper, in terms of multiples,” says Fahey. “Bear in mind, we could see a big decline in earnings — maybe 20%-30% lower in 2009 from 2008.”

It could be worse, he adds, for instance, resources companies will suffer considerably because of falling commodity prices.

Although Fahey would not be surprised if markets fell another 10%-15% between now and the end of the year, he says: “Where you see good opportunities, take them.”

A value investor, Fahey is running a 75-name fund. One favourite name is Sampo Oyj, a Finnish firm that is the largest non-life insurance company in Scandinavia. The firm also has a life insurance division; a 10% stake in Nordea Bank AB, a large Swedish bank; and about one billion euros in cash. A long-term holding, the stock price has recently fallen to 13.4 euros a share from 22.3 euros a year ago.

“The attitude out there is: ‘Get rid of all financials.’ Stocks like this get hit in the process,” says Fahey.

He has added to the fund’s position in Sampo lately, and expects it to rebound to around 14 euros a share within several months.

Another favourite is Man Group PLC. The London-based hedge fund manager has about US$75 billion in assets under administration. In the past, its share price has been closely correlated with its hedge fund division, AHL, which has had a 12.9% average annual compound return since 1993.

But the market’s extreme bearish view has severed that linkage and Man Group’s stock price dropped recently to 290 pence a share, from a high of 639p in July.

“It’s trading at eight times fiscal 2009 [ending March 31] earnings. That’s cheap to us,” says Fahey, noting that the stock pays an 8.9% dividend.



It’s too soon to say that markets have stabilized, says Vittorio Fegitz, senior portfolio manager with RBC Asset Management U.K. Ltd. He oversees RBC European Equity Fund.

“One can say two things, however,” he says. “Whatever happens, we will come out of this with a functioning banking system, although slightly different from the one we are used to because large chunks will be owned by governments. And the economy will go on; there will still be wealth creation.”

However, profitability will probably be lower than in the past few years. “But this very significant [market] decline discounts quite a negative scenario of earnings,” says Fegitz, “leaving scope for upside in equities, once the banking system has stabilized.”

The longer-term price trend has fallen to 10.8 times earnings, he adds.

“The market seems to be discounting a 40% fall in earnings,” says Fegitz, noting that the long-term average trend is 14 times. “When stock prices reflect such bad news, in many ways the risk/reward relationship favours entering markets. By holding on at these levels, there is scope for equities to bounce back. But it does require some resolution of the banking difficulties.”

Fegitz believes this is a “good entry point [to invest] — if one isn’t too ambitious.” But he would not be surprised if a rally occurred toward the end of the year, given how far markets have tumbled.

Running a 56-name fund, Fegitz is a bottom-up stock-picker who uses a blend of quantitative and qualitative screens to identify target companies. He seeks firms with good earnings growth and earnings momentum, balance sheet strength and reasonable valuations; he focuses on firms whose return on investment is higher than the cost of capital.

From a technical viewpoint, Fegitz tends to be contrarian and prefers out-of-favour industries, such as pharmaceuticals. Stocks that score well in his analysis tend to result in large holdings in large-cap names — BNP Paribas SA, Novartis AG, HSBC Holdings PLC and Royal Dutch Shell PLC.

But he also likes mid-cap names such as De La Rue PLC. Based in Britain, the firm is the world’s largest printer of banknotes.

“It’s in an industry in which there are considerable barriers to entry, but with very high returns,” says Fegitz. “The company is benefiting from earnings growth and earnings revisions because the demand for banknotes, especially in emerging markets, is very strong because of inflationary pressures. At the moment, it has good operational momentum.”

Acquired about six months ago, the stock has held its own and recently traded around 885p a share. Fegitz has no stated target.

Another favourite is AstraZeneca PLC. Like many pharmaceutical firms, it has suffered because of extreme pessimism about the industry and its ability to develop new drugs.

But Fegitz is upbeat because the firm has struck a deal with a generic drug-maker to extend the patent protection on an important and profitable acid reflux drug, Nexium.

A long-time holding in the RBC fund, AstraZeneca has seen its share price fall to 2,075p recently, from 2,700p last June. However, Fegitz is staying the course.

“As long as the technicals look good,” he says, “and our stocks have positive earnings revisions, and valuations are not too extended, we are going to run with them.” IE