European equities have certainly had a good run over the last few months. Despite conflict between Ukraine and Russia as well as looming fears of a potential ‘Grexit’, European stocks have proved to be hugely popular among investors.
A recent survey of 159 Fidelity global analysts showed a preference for the European market, rating it one of the best investment opportunities alongside Japan.
It’s not surprising when you take into account the eurozone’s current combination of lower interest rates, a weaker euro, subdued inflation, money-printing from the European Central Bank and lower oil prices, as well as the fact it looks cheap compared with its peers.
So why have Roubini Global Economics and ETF Securities joined forces to warn that Europe’s rebound could be fleeting?
“We have ratcheted up our forecasts for Europe, where we expect a mild cyclical recovery to persist for a few quarters thanks to monetary stimulus and a bit of good luck,” their latest Quarterly Outlook report said.
“We are seeing a growth improvement in Europe on low rates and low oil prices, but fiscal support and structural reforms are needed to make the recovery more substantial, while a heavy political calendar could spoil the party.”
Earlier this month, Roubini Global Economics chairman Nouriel Roubini, whose earned the nickname “Dr Doom” by predicting the financial crisis, warned that investors aren’t noticing an important headwind for Europe.
He notes that Germany as the eurozone’s “engine” but suggests that this country, rather than Greece, is the one that needs to be considering reform if the eurozone project is to be saved.
The economist says that the large external surpluses being run by Germany and the rest of the eurozone core threaten to hold back the region’s stimulus efforts and are reflected in weak domestic demand. This will also mean that the ECB’s monetary policy could create trade and currency tensions with the eurozone’s trade partners.
Writing on Project Syndicate, Roubini said: “Germany needs to adopt policies – fiscal stimulus, higher spending on infrastructure and public investment, and more rapid wage growth – that would boost domestic spending and reduce the country’s external surplus.”
“Unless, and until, Germany moves in this direction, no one should bet the farm on a more robust and sustained eurozone recovery.”
Europe has returned to favour with some investors after the ECB unveiled a €1.1trn quantitative easing programme earlier this year. Expected to continue until at least 2016, the programme was launched to tackle inflation and boost consumer confidence.
Since QE was launched, the MSCI Europe Index has overtaken the MSCI World as shown in the graph below, which is a far cry from Europe’s disappointing performance over the past year, as its index lagged behind MSCI World.
Performance of MSCI Europe Index vs MSCI World Index since QE launch
Source: FE Analytics
However, Apollo’s Ryan Hughes thinks that QE is not sufficient enough to give support to the market over the longer term. 
"It is clear that structural reform is key to the success of Europe. Mario Draghi at the ECB has made this point numerous times and has been clear that QE can only do so much but ultimately it is down to individual governments to put in place appropriate structural reform to drive long-term growth.”
“Over the shorter term, what investors need to see now is corporate profits start increasing to match the lofty valuations of equity markets. Without this gap being closed, it is possible that the momentum of European markets could wane.”
The concept of QE as a short-term fix correlates with Roubini and ETF Securities’ belief that Europe’s recovery is only cyclical.
Their report states that in order to cope with increased growth in the eurozone, reforms are required to break the loop and boost the market’s strength over the long-term.
“Taken together, low oil prices and low interest rates will loosen financial conditions in Europe, encourage consumption, which is the bloc’s main growth driver, and lead to a boost in net exports,” they said.
“However, the cyclical upswing will only turn into a more sustained expansion if stronger consumption and more accommodative financial conditions stimulate corporates to invest. That still looks to be only an upside risk, despite the improvement in sentiment indicators.”
Not only do investors have to worry about the potential need for reforms, there is a series of geopolitical factors which are turning some investors bearish on Europe.
For instance, Grexit fears have not completely left since the start of the year as negotiations are still ongoing. What’s more, the Russia/Ukraine crisis could worsen at any point, which could hamper investment plans in Europe as well as impact energy supplies.
Elections in western Europe can also be added to the cooking pot, as the impending Spanish and UK elections could upset order and spook the markets.
“2015 is a year of European elections, as voters get a chance to kick out those politicians who signed off on austerity measures,” Roubini and ETF Securities’ report continues.
“Investment will be restrained by the complex geopolitical environment and challenging political/electoral cycle – and to a greater degree than market consensus or EU estimates would suggest, especially in Spain.”
“The UK election in May will also hamper investment. A Conservative victory would set the stage for an EU referendum in 2017, while a Labour win would pose fiscal concerns, neither of which would be positive for investor sentiment.”
Hughes believes that anyone investing in Europe can’t do so without keeping one eye on the political situation, given the complexities that are shrouding the market.
He said: “While the support of QE at present is likely to outweigh the risk that come from politics, Greek issues still have the potential to cause major trauma, and investors should be ready to act quickly if there are signs that this is escalating into something more serious.”