Bolton, head of the firm’s European equity team, says that despite last year’s market rally, European shares are trading at very attractive valuations compared with other markets.
While he acknowledges there have been increased inflows into European funds recently, he says the region remains under-represented on a historical basis.
"After a trough in activity last summer, global leading economic indicators have been improving across the US, Europe and China, and the outlook for 2013 looks brighter than for 2012. This background is supportive for equities," he commented.
"We have seen a marked increase in investor flows towards European equities since the ECB’s game-changing intervention in the summer of 2012."
"From a near-record underweight position in European equities in June there have been sizeable inflows into European equities, which are now being seen as more investable."
"However, positioning remains low relative to historic levels, with few investors overweight."
"These flows initially came from cash and US equities but also more recently from some investors switching out of bonds. The latter is very significant as it is the first time we have seen this for many years. If this continues, and we believe the valuations strongly support this, we are only mid-way through a bull market."
"Despite last year’s rally, we see potential total returns for European equities of around 15 per cent in 2013," he added.
European markets were the most successful in terms of capital returns last year.
Performance of indices in 2012
Source: FE Analytics
According to FE Analytics, the MSCI Europe index returned 13.89 per cent in 2012, beating the FTSE 100 and the S&P 500, which returned 9.97 per cent and 8.42 per cent, respectively.
So far this year MSCI Europe is the highest performer out of the indices mentioned.
In spite of of this, Bolton says European equities are still trading on historically low price/ earnings (P/E) ratios.
"Despite the rally in 2012, the market remains attractively valued, both versus its historic average and against other major developed equity markets. When looking on a P/E basis, the European market is 15 per cent below its historic long-term average."
"It is also trading on a 25 per cent discount to the US equity market; this is close to its highest historic discount, which typically stands at 8 per cent on average."
"Finally, when looking against other asset classes, the European equity market also stands at an attractive valuation, offering an earnings yield of 8 per cent and a dividend yield of 4 per cent – both significantly more attractive than the lower yields investors currently achieve on cash or on low-risk sovereign bonds."
"This clearly highlights that risk aversion towards European equities remains high," he added.
As the seemingly perennial eurozone crisis is easing, Bolton now thinks that the US will provide investors with the most headaches.
"The US is the new focus of investors’ worries," he said.
"Indeed the eurozone is showing more progress in making its deflationary structural adjustment than America."
"This is because it took the fiscal pain up front to a far greater degree than the US. Consequently, current account imbalances on the periphery are improving."
He added: "Investors are slowly realising that their underweight position is no longer sensible."
"However, it is fair to say that the political momentum, and therefore the economic momentum, remains fragile. It is important that there is no slippage in political actions, which could change the macro-economic picture rapidly from the one that we are portraying here."
As policy makers are yet to agree on how to resolve the fiscal cliff once and for all, Bolton expects a large number of investors to ditch their US exposure for European equities in the coming months.
"If anything, the US fiscal cliff uncertainty is shifting some of the risk from the eurozone towards the US, further highlighting the valuation discount of European equities relative to their US peers."
"Providing there is no major political slippage in Europe, we expect further inflows into the region’s equities into 2013," he finished.