October 2010

The Case For Europe

Things are looking up in Europe Investors have been turning their backs
Europe, racked by sovereign debt issues and thus concerns over on Europe but BlackRock continues to
the sustainability of the recovery, has been at the centre of macro
concerns for much of the year, and in aggregate has seen investors
look positively towards a market which
sell up and leave. After strong outflows in April and May, however, currently offers the best dividend yields
interest in European equity funds has begun to pick-up as second
quarter company results surprised positively.
of the developed markets.
The market moves that we have seen over recent months are
reminiscent of its moves in 1994 when the market fell on initial
concerns that the slowing economic momentum might roll over into
a double-dip recession. Back then, strong corporate earnings and
stabilisation in economic growth expectations provided a bottom
for the market. We believe that a similar outcome is likely over the
next few months as macro fears subside. In other words, European
equities can perform well when the economy slows.

Lessons from history

1994–1996 saw an economic slowdown…
4%

Eurozone GDP forecasts declined to zero

3%

2%

1%

0%
03.94 05.94 07.94 09.94 11.94 01.95 03.95 05.95 07.95 09.95 11.95 01.96 03.96 05.96

Eurozone Quarterly GDP Forecast (annualised)

Source: Credit Suisse, Bloomberg, as at August 2010

…but European equities continued to perform

140

130
Market gained 30% in the same period
120

110

100

90
03.94 05.94 07.94 09.94 11.94 01.95 03.95 05.95 07.95 09.95 11.95 01.96 03.96 05.96

FTSE World Europe ex UK (GBP)

Source: Credit Suisse, Bloomberg, as at August 2010
Continued growth,
but with slowing momentum
We acknowledge that an economic slowdown is under way and
some leading indicators have rolled over, which is consistent
with the fading of growth from an inventory rebuild. However,
we do not expect a slide back into recession. Overall, economic
growth persists in Europe. Just to give an example: Germany is
still accelerating according to the IFO Business Climate index with
German industrial production growth rates reaching new highs. In
the second quarter, Germany’s economy grew at the fastest pace
(by 2.2%) since the country’s reunification two decades ago as the
global recovery has boosted exports and companies stepped up
investment. Europe’s largest economy is benefiting from buoyant
exports and a recovery in global demand just as the euro’s decline
against the US dollar this year makes its exports more competitive
outside the Euro currency bloc.
This re-iterates our view that the growth map in Europe is changing
and that future growth trends within the Eurozone will be driven by
core markets (core Europe is 88% of the FTSE World Europe ex UK
index) as opposed to the periphery which had been the key growth
engine of the past 15 years. Many gross domestic product (GDP)
growth forecasts for Germany are now being revised up to over 3%
for 2010. While the periphery has dominated headlines this year
Earnings growth is key to equity
performance
In addition to this positive growth environment, it is important
to note that the European corporate profit cycle remains strong.
European companies’ earnings prospects and corporate balance
sheets are in good shape with attractive dividend yields, particularly
in core markets. With net cash on their balance sheets, we would
expect European corporates to look for merger and acquisition
(M&A) opportunities in the coming months. Moreover, equity
valuations are cheap relative to history and also relative to other
markets, and also cheap versus bonds.
Europe is cheap relative to history
and also cheap versus bonds
Market needs to rally 20% to reach long-term average
25
20
15
10

and remains weak, it’s worth highlighting that Germany accounts

for more than 20% of Eurozone GDP, while Portugal, Ireland, Greece 5
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
and Spain (PIGS markets) combined account for just 11%. Eurozone Average +1Std Dev –1Std Dev

Source: Credit Suisse as at August 2010

Percent of benchmark
Country
(FTSE World Europe ex UK)
Eurozone dividend yield versus Eurozone bond yield
France/Belgium 25.2%
12
Germany/Netherlands 24.1%
10
Switzerland 17.7%
Scandinavia 13.2% 8

Other Core 9.2% 6

Spain 8.6% 4

Greece 0.6%
2
Portugal 0.8%
0
Ireland 0.7% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Eurozone Dividend Yield Eurozone Bond Yield
Source: Credit Suisse as at August 2010
Source: Credit Suisse as at August 2010
Key themes
For the overall world economy, the International Monetary Fund
(IMF) global forecast for 2010 has been increased every month
this year despite concerns over US growth, partially as a result of
stronger growth in Europe and Asia. Global economic growth of
three per cent next year is a decent backdrop for equity investment.
However, as demographics are an increasing headwind for the global
economy, it is unlikely that benchmarks or ‘beta’ will provide the
sort of returns from equities that will satisfy the needs of an ageing
and retiring population.

As work forces age, moving towards retirement, the question as

to who will pay for the ageing population is key. Furthermore, global
population growth is significantly declining over the next 20 or 30
years, and some postulate will stop altogether. These factors are
clearly longer term issues and likely to cause significant changes
in patterns of consumption, savings and investments.

Another factor is the deficiency in savings in the developed world,

particularly in the US and UK of the major economies. This situation
will either require a significant sub par consumer performance in
recovery as savings are rebuilt, or low levels of capital formation
because of insufficient funds for investment. A third possibility is a
continuing very high level of current account deficits as capital is Current opportunities in Europe
imported. Furthermore, debt is crowding out growth in a number of
economies with more than a total deficit relative to GDP extremely Overall, Europe offers some of the world’s
high in a number of developed economies and ability to repay
relatively low as high fiscal imbalances remain in e.g. Ireland, UK,
greatest franchises at cheap valuations
Spain, Greece and the United States. France, Germany and China with significant levels of exposure to
have no such issue, but it is against that backdrop that it is no
surprise that the slowest recovery in US consumption in history has
the most attractive trends in emerging
taken place since the trough of the US economy. markets. In fact, more than 20 per cent of
quoted corporate revenues in Europe this
year will come from emerging markets.
One example is the auto sector in Russia which has a significantly
different growth path to China i.e. an 8 per cent fall in GDP 2009,
has seen a foreign car market of 70,000 units against 200,000
in March 2008, although it is now recovering to approximately
100,000 (these are sales of foreign brands of cars).

Across Europe there are many similar stories. We see strong

analogies to the era of the “nifty fifty” of high quality shares in
the United States in the 1960s and 1970s. Although this trend in
US stocks became something of a bubble in the mid 70s, when
valuations became extreme on this loose group of high quality
growth stocks, investors who bought at the top of that valuation
bubble and continued to hold through to today, performance
would not have been too disastrous versus the wider market as
the earnings growth has caught up with the valuations i.e. buying
high quality companies, even at what appear to be comparatively
expensive prices, tends to work over the long haul unlike buying
overvalued technology stocks on Nasdaq in 2000.

Conclusion
As a whole Europe has many examples of cheap shares, in aggregate has high yields relative to bonds at present,
and is cheap relative to history and also relative to other markets. There has been a significant retreat from
ownership of European equities as peripheral economic weakness has scared investors but the weaker euro and
strong corporate profit cycle provides a very attractive entry point for long-term investors. A skilled team such as
BlackRock’s has scope to add significant value in the current environment.
Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally.
The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or
any part thereof and no assurances are made as to their accuracy. Past performance is not a guide to future performance. The value of investments and the income from them can fall
as well as rise and is not guaranteed. You may not get back the amount originally invested. Changes in the rates of exchange between currencies may cause the value of investments
to diminish or increase. Issued by BlackRock Investment Management (UK) Limited (authorised and regulated by the Financial Services Authority). Registered office: 33 King William
Street, London, EC4R 9AS. Registered in England No. 2020394. Tel: 020 7743 3000. Tel: 020 7743 3000. For your protection, telephone calls are usually recorded. BlackRock is a
trading name of BlackRock Investment Management (UK) Limited. Issued in Switzerland by the representative office, BlackRock Investment Management (UK) Limited (London), Zurich
Branch, Claridenstrasse 25, Postfach 2118 CH-8022 Zürich from where the Company’s Prospectus, Simplified Prospectus, Articles of Association, Annual Report and Interim Report are
available free of charge. Paying Agent in Switzerland is JPMorgan Chase Bank, National Association, Columbus, Zurich Branch Switzerland, Dreikönigstrasse 21, CH-8002 Zurich. Issued
in Hong Kong by BlackRock (Hong Kong) Limited. BGF has been registered on the official list of the Financial Supervision Commission (Komisja Nadzoru Finansowego) for distribution
in Poland. Issued in Poland by the representative office BlackRock Investment Management (UK) Limited Oddzia? w Polsce, Rondo ONZ 1, 00-124 Warszawa. Paying agent in Poland is
Bank Handlowy w Warszawie SA, ul. Senatorska 16, 00-950 Warsaw, Poland. Issued in Singapore by BlackRock (Singapore) Limited. This material may only be distributed to institutional
investors (as defined in section 4A of the Securities and Futures Act, Chapter 289 of Singapore (the “SFA”) and accredited investors (as defined in section 4A of the SFA) and not to the
retail public in Singapore. This material is for information purposes only and does not constitute an offer of shares in any of the BlackRock Global Funds. You should consider carefully
whether the investment is suitable for you.For further information, the prospectus, simplified prospectuses, annual report and semi-annual report can be obtained free of charge in
hardcopy form from the Austrian paying agent: Raiffeisen Zentralbank Österreich AG, A-1030 Vienna, Am Stadtpark 9.BlackRock Investment Management (UK) Limited is authorised and
regulated by the Financial Services Authority. Registered office: 33 King William Street, London, EC4R 9AS. Tel: 020 7743 3000. Registered in England No. 2020394. For your protection
telephone calls are usually recorded. BlackRock is a trading name of BlackRock Investment Management (UK) Limited. Issued in the DIFC by BlackRock Advisors (UK) Limited - Dubai
Branch which is regulated by the Dubai Financial Services Authority (‘DFSA’). This document is directed at ‘Professional Clients’ only within the meaning of the rules of the DFSA and no
other person should rely upon the information contained within it. None of the funds are subject to any form of regulation or approval by the DFSA. The DFSA has no responsibility for
reviewing or verifying any Prospectus or other documents in connection with these funds. Accordingly, the DFSA has not approved the Prospectus or any other associated documents
nor taken any steps to verify the information set out in the Prospectus, and has no responsibility for it.

For more information: Tel: Int. +44 (0)20 7743 3300 Website: blackrockinternational.com
Tel: UK 08457 405 405 Website: blackrock.co.uk

09655BR Oct10