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The TSC Streetside Chat: Michael Levy of Deutsche Asset Management

David Kurapka

In a year that many investors would probably just as soon forget, Michael Levy has shined. He is head of international equity at Deutsche Asset Management and co-lead portfolio manager of the firm's (BTEQX Quote - Cramer on BTEQX - Stock Picks)International Equity Fund, which is up 14% in the last 12 months. He is also lead portfolio manager of the (MEUVX Quote - Cramer on MEUVX - Stock Picks)Deutsche European Equity Fund, which is up a whopping 88% since its introduction late last year and has been one of the top 10 performers of all funds this year.

Levy joined Deutsche Asset in 1993 after 23 years of experience in various positions in investment banking, technology and manufacturing enterprises and as senior equity analyst at Oppenheimer & Co. He recently met with TheStreet.com's David Reilly and David Kurapka to discuss the state of the global economy, the effect of high oil prices and a weak euro, as well as international investment opportunities.

TSC: Why should U.S. investors pay attention to investing outside the U.S. right now? Markets everywhere seem pretty shaky, but in the U.S. at least the economic situation is pretty strong. And markets move in synch with the U.S. anyway. So what's the case for investing outside the U.S. at this point?

Michael Levy: Well, first of all, I would call into question whether or not markets actually move in synch with the U.S. I think when the U.S. market has a particularly strong move, namely on the day that it may have that move, it does appear to have a very strong influence on other market behavior.

But I don't think that's the case when you look at how the markets are correlated on a one-month, three-month, six-month or one-year perspective. Markets, in fact, do move in different directions sometimes, but certainly in different orders of magnitude. And the U.S. is not, by any means, the best-performing of those markets at any point in time.

TSC: So where do you think the best-performing markets will be?

Michael Levy: There are several reasons why we should question whether the U.S. will continue to do well based on the fact that it has historically done well. That also clearly has kept upward pressure on the dollar and, overall, that's been a net positive for the U.S. However, dollar-based investors are now in a position to look for opportunities where they can achieve the best return in assets that are priced in something other than dollars. I think European assets in general, and Continental-based assets in particular, are getting very attractive for the U.S. dollar-based investor. So that would be, I think, the most interesting place to be investing right now on a six- to 12-month view.

TSC: And you say that despite a euro that's done pretty poorly since its introduction?

Michael Levy: Yes, I do. In some ways, I say it almost because of how the euro has done since its introduction. There are definitely some negative side effects for Europeans and the European markets, owing to a weakening of the currency. But, by and large, the effects are probably more positive than negative and certainly from the perspective of dollar-based investors, I think they end up being very positive.

European companies and European economies went through a tremendous amount of change just getting to the point where it was possible to introduce the euro. In other words, in order to meet the criteria that they themselves set, it took many years of belt-tightening, shrinking of government. Companies have, in fact, begun a very difficult restructuring process in order to compete in a market environment. It's a world of opportunity, but clearly it has its challenges.

TSC: Why did the euro head south so quickly?

Michael Levy: I think the major reason is that European companies, which had excess capital and were under pressure to improve their own global position, found attractive U.S. companies to invest in. And so the fund flows have been out of euros and into dollars. In the mid-80s, the dollar was very high but after the Plaza Accord, it dropped from close to 3.5 deutsche marks to under 2 deutsche marks in a two-year period. That is a greater fall than what the euro has experienced against the dollar in the 18 months since its introduction.

What did the fall of the dollar do for U.S. companies and the U.S. equity market? It provided a tail wind for companies to be able to benefit from restructuring, focus on global opportunities and become more competitive. That resulted in a very exciting bull market in U.S. equities for the decade. Well, Europe is not necessarily in a very different position right now. It's gone through a lot of pain, just as the U.S. went through restructuring of the corporate sector in the '80s. I think you can make almost a direct comparison with Europe today. "European assets in general, and Continental-based assets in particular, are getting very attractive for the U.S. dollar-based investor."

TSC: However, Europe, while it now has economic union, still does not have political union. What would you say to the people who say, because of that, ultimately the euro is doomed?

Michael Levy: I don't think they see the whole picture. I think that political and regional differences in Europe, while they are apparently more dramatic than what the regional and political differences are here in the U.S., we in fact have many subeconomies. There are significant differences as one moves from region to region, even from city to city in this country. So we're not all that homogeneous. The fact that capital is more mobile and labor is more flexible here took a number of years to create. Clearly, that was not the case at the end of the '70s. The U.S. had at least as sclerotic a labor movement, as much structural unemployment as Europe has now, if not more.

In fact, capital now is very mobile in Europe and labor is becoming more flexible in very interesting ways. The labor unions no longer have the power to negotiate monolithically with large industries on behalf of their members. Temporary help, meaning full-time temporary, rather than permanent staff, is becoming a way of reducing unemployment. Countries such as France have the highest penetration of temporary help in the G7. It's a fairly unknown fact, but the fact is that unemployment has been coming down. And I think that the political differences are probably exaggerated. It is clearly the case that Europe is in an earlier stage now in terms of reaching some form of political unity. But I wouldn't be surprised to see that in five to 10 years there is some form of political federation that supplants the EMU [European Monetary Union].

TSC: OK, let's say that the comparison with the U.S. in the mid-80s is valid and that, in fact, what's happening with the euro right now might be setting the stage for what will be -- obviously we're talking medium- to long-term here -- some sort of bull market in Europe. What companies would you be looking at now as a good way to position yourself for this?

Michael Levy: We would be looking at companies over the long haul, companies that have positioned themselves to be more competitive, to improve their returns for their shareholders, to take advantage of economies of scale, both within the European region and globally. And there are companies in the consumer staples area, from financial services companies like ING(ING Quote - Cramer on ING - Stock Picks), to an integrated oil company like Total Fina Elf(TOT Quote - Cramer on TOT - Stock Picks) and Carrefour. The world's second-largest retailer happens to be a French company and it has, without question, positioned itself to give Wal-Mart(WMT Quote - Cramer on WMT - Stock Picks) a run for its money in many markets around the world. "I wouldn't be surprised to see that in five to 10 years there is some form of political federation that supplants the EMU."

TSC: It seems the companies you mentioned are more dependent on growth within Europe as opposed to the Nokias(NOK Quote - Cramer on NOK - Stock Picks) that are more dependent on global growth. After all, if the U.S. is slowing down and Europe is taking off, won't that hurt Europe if there's a slow U.S.?

Michael Levy: Some of these companies I've mentioned have less exposure to the U.S., some have more exposure to the U.S. Right now, with the strong dollar, that's obviously been a benefit. It's not clear at what point Europe will be running economically at the same or higher rate than the U.S. The hardest call right now is just what kind of landing, if at all, we have here in the U.S. I think what's important is that Europe is in a position to continue to grow without experiencing the kinds of excesses we've already seen in this country, in terms of debt levels in the consumer sector, in the corporate sector. Balance sheets are much healthier, Europe-wide now, in particular in euroland.

The potential for growth is still fairly significant. Whether they do that at 2.5% or 3.5% to 4% on any sustainable basis remains to be seen, but the important thing is that it can continue. And although there are concerns about energy prices, clearly, energy being priced in dollars, this is a concern. That being said, Europe still has significantly lower headline and core inflation than the U.S and will, probably, for the next several years at least. And Europe is also a lot less sensitive to energy in general, just because it's a more energy-efficient place than the U.S.

TSC: If a U.S. investor said to you, what are three companies you think I should take a look at in Europe that I can buy on U.S. markets, what would you say to that person?

Michael Levy: I would look at Total Fina Elf, which has a big, liquid ADR. Probably, I would look for a window to buy Vodafone(VOD Quote - Cramer on VOD - Stock Picks). We are underweight, but I think Vodafone is going to be one of the great survivors in what could be a problem sector in the near term. I think Nokia is another company that has been beaten up recently, but one that would be worth looking at given its cash-flow growth and the fact that it's not valued all that richly.

TSC: Let's move outside Europe. How do you view the prospects in Asia?

Michael Levy: We're a little bit less enthusiastic about Asia. The fact is that, with the exception of China, Asian growth has peaked in the near term. However, we think that there are a number of areas in Asia that are attractively valued. I think Samsung Electronics is just mouth-wateringly cheap. And here we have a global world leader in semiconductors; they're up-and-coming in terms of advanced technology handsets. It's really a powerhouse of a company and it's being bought for single-digit multiples of everything, including P/E [price to earnings] at this point. It's been dramatically oversold. Of course, it's been caught in the crossfire having to do with the problems in South Korea, with the restructuring of the Daewoo chaebol. But that's going to pass. "Europe is in a position to continue to grow without experiencing the kinds of excesses we've already seen in this country, in terms of debt levels in the consumer sector, in the corporate sector."

TSC: How much worry do you think there is right now that in addition to the Daewoo problem, Korea, like many parts of Asia, is an industrial producer that is pretty oil-dependent?

Michael Levy: Yes, oil is hurting GDP and will hurt GDP in the next two years. Just the fact that it's already been high as it flows through those economies, it's going to take probably between 50 and 100 basis points out of GDP. But that's true, by the way, for all of the [Organization for Economic Cooperation and Development], not just South Korea. It's going to hurt. I think it's probably largely in the price at this point, but sentiment is still very negative. And just exactly how Daewoo is restructured remains to be seen. And there are obviously sectors, such as banking, where you can't help but think there could be further damage. That being said, there are going to be companies that rise above this and I think something like Samsung is probably not a bad bet. But, again, timing it could be difficult.

TSC: After the '97 crisis, while there were a lot of reforms undertaken, in many cases they were half-hearted and many problems weren't fully dealt with. Is there any chance that we could see another Asian currency crisis within the next 12 months?

Michael Levy: The currencies have not exactly recovered to where they were precrisis. My guess is that there is some downside risk. There could be another banking crisis in the region. I think the likelihood is lower, but there's definitely the possibility. I'm not necessarily advocating that people run out and buy everything in South Korea, because I do think there are risks. A company like Samsung really could well rise above the fray, but it will also suffer, sentimentwise, if there is further downside near term in South Korea. There is always currency risk in emerging-market investments and I think this is no exception.

TSC: How about Japan?

Michael Levy: Japan is a market that has traversed a trading range up and down now, I don't know how many times in the last 10 years. And, unfortunately, we're now somewhere in the middle bottom of that range. I suppose that's the bad news and the good news. It clearly is more attractively valued than it has been for some time as a market.

We are encouraged by some of the signs of restructuring at the company level and are happy to invest in a number of companies there. I think Sony(SNE Quote - Cramer on SNE - Stock Picks) is certainly worth looking at, at these levels. But the market itself is, well, the economy is going through some difficult adjustments and, in particular, it's facing a slowdown globally. They've been waiting for the largest part of the economy, which is the consumer sector, to revive in some kind of sustainable fashion and that never seems to happen. And partly it's understandable. Job security is being threatened. Companies are going to go through a very long and slow restructuring process. And Japan is living on borrowed time, to some extent. Fiscal spending has been enormous over the last 10 years. Japan is the world's largest debtor nation and it's really getting to the point where it's serious. As you probably know, Japan was downgraded by Moody's [Investors Services]. That isn't of major import right now, but it's not a wonderful sign.

Our view of Japan is that we see some signs of progress. We're generally skeptical and think that the economic transformation that it needs to go through to become a bona fide market economy is going to take years, not months or quarters, and so we prefer to just keep looking for interesting stocks to invest in. It's a mixed picture. "The fact is that, with the exception of China, Asian growth has peaked in the near term."

TSC: What type of allocation do you have in terms of different regions? How would you split up a portfolio?

Michael Levy: In our international portfolios we really don't make allocations to regions or to markets. We let our bottom-up investments determine what our sector and country allocations will be. So I can tell you what our allocations are, but that isn't necessarily what we would recommend somebody do. With that as a caveat, we are fully weighted in Europe. We have about 65% of our diversified international portfolio in Europe. And over 50% of that, about 52%, is in the Continent, or Europe ex-U.K. And the U.K. represents about 15%. That's been slowly creeping up as the sterling has weakened somewhat, removing some of the headwind to the U.K. economy and also to the U.K. corporate sector in terms of earnings development, so we're finding some more interesting companies to invest in.

Our Japanese exposure is in the low to midteens. And our emerging market exposure is under 5%. Our favorite markets are in South America, particularly Brazil, and some of the European markets. We still have some exposure in South Korea and Taiwan, but all told it's a little, about 6% in emerging markets, Pacific ex-Japan, about 4.5%. We also have a little over 4% of our exposure in Canada, which is a market that we look pretty favorably on and have several investments in. Canada tends to be overlooked in global investing. It tends to fall through the cracks, but it's in our investable universe. So we actually have over 4% in Canada now.

TSC: Why is Brazil your favorite emerging market?

Michael Levy: We think that it's doing a lot of the right things in terms of fiscal discipline. There are positive surprises in terms of the direction of interest rates. There's a lot going right in terms of the macro picture and there are some interesting, very attractively valued companies vs. their global peers that are well-positioned and some of the major ones, like Petrobras(PBR Quote - Cramer on PBR - Stock Picks), and some of the telecommunication stocks. So it just ends up being our largest exposure among our emerging market countries.

TSC: You're pretty bullish on Europe, obviously.

Michael Levy: Cautious.

TSC: Are you also bullish on emerging Europe?

Michael Levy: Reasonably. I think that as markets in Europe go through a consolidation, which they're beginning to go through right now, perhaps even setting themselves up for a fourth-quarter rally, the emerging markets at this moment are not as interesting. There are issues. The markets we like from a more secular perspective -- Poland, Turkey, Hungary, we still have some exposure in Greece -- we think these are going to be very interesting markets over the next few years, but you really have to be mindful of what the political environment might be and there are issues now facing a lot of these markets. I wouldn't rush people into country funds at this moment.

TSC: Michael, anything else you'd like to add?

Michael Levy: We've actually been able to put together a portfolio that trades at a discount to the market. And both our European and our international portfolios trade at a discount to their respective market benchmarks and capture significantly higher growth opportunities. You have to be mindful that this is looking forward on at least a 12-month horizon. Trying to predict what will happen in the next three to six weeks and even three to six months is getting to be more difficult as the markets churn.