- The recent decision by ECB to reduce a key lending rate to below zero is an acknowledgement that the euro zone recovery is teetering.
- The United Kingdom offers an interesting way to capitalize on the compelling valuations without the same level of economic consternation as exists on the continent.
- The iShares MSCI United Kingdom ETF has in fact picked up steam in the second quarter.
By Carla Fried
The recent decision by the European Central Bank to reduce a key lending rate to below zero is an acknowledgement that the euro zone recovery is teetering. Exhibit A: inflation rates that are either in or near deflation territory.
At the same time, European stock valuations, though having expanded over the past year, are still a better relative value than the U.S. But if the continent's economic malaise leads to a slide back into recession, even well-valued stocks aren't going to a haven.
The United Kingdom offers an interesting way to capitalize on the compelling valuations without the same level of economic consternation as exists on the continent. The United Kingdom's 1.75% CPI rate puts it in the camp of the United States, where deflation isn't entirely off the table, but nor is it a front-of-mind-concern as it has to the for Mario Draghi and the Eurozone's central bankers. Moreover, at the end of the first quarter, the 16.9 trailing 12-month PE ratio for the MSCI United Kingdom stock index was below its 15-year norm of 18.
The iShares MSCI United Kingdom ETF (NYSEARCA:EWU) has in fact picked up steam in the second quarter:
The five largest positions in the iShares MSCI United Kingdom ETF are HSBC Holdings (NYSE:HSBC), BP (NYSE:BP), Royal Dutch Shell (NYSE:RDS.B), GlaxoSmithKline (NYSE:GSK) and British American Tobacco (NYSEMKT:BTI). They may be domiciled in the United Kingdom, but those are five very global companies, with significant exposure to emerging markets, where the case is strongest for long-term growth prospects. Yet they are trading at forward PE ratios that are more in line with a sluggish Euro outlook.
GlaxoSmithKline stands out as an especially interesting UK-based global powerhouse. Its current valuation is well below its five-year norm:
Though no cash flow competition for Johnson & Johnson (JNJ), GlaxoSmithKline has seen a sharp rebound since late 2012:
And over the past five years it has actually edged out Johnson & Johnson's EPS growth:
Meanwhile, there is a 4.5%+ dividend yield. GlaxoSmithKline, whose debt is currently well within the investment grade class, currently delivers a better income proposition than the junky PowerShares Senior Loan ETF (NYSEARCA:BKLN) of bank loans.
Wine and spirit maker Diageo (NYSE:DEO) is another top 10 holding of the iShares MSCI United Kingdom portfolio. It also happens to be a top five pick for the standout Oakmark International mutual fund -- and in the first quarter the deep value fund was still adding to its Diageo position. At the same time, the global Oakmark fund established a new position of nearly 2% in Diageo. And Oakmark Equity Income has a 2.5% position in Diageo. The shop that only owns stocks it deems to be trading at a significant discount to their estimate of intrinsic value clearly has consensus that Diageo delivers just that.
While revenue and EPS growth has been strong, Diageo's price-to-book value has not measurably increased.
With a strong foothold in emerging markets-more than one third of revenue-Diageo is well positioned to capture the long-term growth in consumer spending in those developing markets.