The US market has outperformed the continent in the year-to-date, as emerging market equities have faltered and the rest of the developed world has struggled to catch up. However, Kreckel (pictured) says that the US’s run could be vulnerable to an unexpected recovery elsewhere in the world, with Europe being a potential candidate.
"Investor surveys suggest sentiment and positioning have become extremely bullish, making US equities increasingly vulnerable to even small deteriorations in the relative macro picture," he said.
"We don’t expect US growth to disappoint, but if part of the attraction of US equities has been their status as the only place to get exposure to improving macro fundamentals and earnings growth, this view could also be threatened by something going right elsewhere in the world rather than something going wrong in the US."
Data from FE Analytics shows that the S&P 500 has made 26.47 per cent in the year-to-date, compared with just 16.62 per cent for the DJ Eurostoxx and 14.67 per cent for the FTSE All Share.
Performance of indices in 2013
Source: FE Analytics
The economic news out of Europe has been more positive of late, with manufacturing PMI figures at an 18-month high, suggesting there could be an end to recession in the eurozone in the third quarter.
Kreckel says that if the good economic news continues, eurozone stocks could recover sharply and outperform US shares.
"From an equity market perspective, the main reason for the underperformance against the US lies in the continuing deterioration of corporate profits," he said.
"Whereas US forward earnings have risen 9 per cent since the start of 2012, eurozone earnings are down 6 per cent over the same period."
"It is no coincidence that this 15 per cent earnings growth gap matches up almost perfectly with the performance gap over the same period. But therein also lays the trigger for European equities to begin catching up."
"In our base case, European profit growth will lag behind the US slightly over the next 12 months. But there is greater upside potential in Europe than in the US if things go well."
"European top-lines should grow more slowly given sluggish domestic economies, but with superior operating leverage and lower margins, it is not inconceivable European earnings could rebound more strongly from a low level."
"This is not our base-case view at this point, but something worth watching in the months ahead."
Kreckel acknowledges that there are still political issues in the region holding back economies.
This point is stressed by Frances Hudson, global thematic strategist at Standard Life, who says investors are overlooking the possibility of a return of the euro crisis.
"I think there are a number of points at which you can see further vulnerability of the euro," she said.
"The markets at last seem not to be reacting as strongly to crises as they did, not to Cyprus, nor Portugal, nor Italy, but the US withdrawal of QE."
"They still have to achieve those plans for banking union and fiscal union, which probably suggests they do not think they are viable and that leaves them vulnerable to the same things that brought them to their knees before."
One way of playing this potential recovery in Europe is through investment trusts, which all stand on discounts to NAV, except for FE Alpha Manager Alexander Darwall’s Jupiter European Opportunities Trust.
Premium/discount to NAV of Europe trusts
| Name | Premium/discount |
|---|---|
| Jupiter European Opportunities |
1.5 |
| Henderson European Focus Trust |
-5.1 |
| BlackRock Greater Europe IT |
-5.2 |
| Henderson Euro Trust |
-6.3 |
| Fidelity European Values |
-9.6 |
| JP Morgan European IT Growth |
-13 |
| JP Morgan European IT Income |
-13.5 |
| The European Investment Trust |
-15.8 |
Source: Numis
The widest discount is on The European Investment Trust, which is currently trading 15.8 per cent below net asset value, according to the AIC, compared with a one-year average of 15.4 per cent.
Stripping out the effect of discount volatility, the trust has made 31.5 per cent in NAV total return terms over the past three years, roughly double the 16.65 per cent made by the FTSE All World Developed Europe ex UK benchmark.
In share price terms it has risen 34.72 per cent, according to data from FE Analytics.
Performance of fund vs benchmark over 3yrs
Source: FE Analytics
According to Andrew Mitchell, analyst at Edison Investment Research, the long-term value approach is well-positioned to respond to any pick-up in sentiment towards Europe.
The fund has 29 per cent in peripheral countries, he points out, and has raised its weighting to financials over the past 12 months.
"The manager’s view is that Europe will move back towards more normal, albeit low, growth, resulting in the current substantial imbalance in stock market valuations, favouring defensives (consumer staples and healthcare cited), progressively correcting as fear recedes," he said.
"The manager believes his value-based process is not distinct from a growth approach and the five-year forecasting horizon should help avoid value traps where growth is limited or negative."
Also on wide discounts are JP Morgan's European IT Income and European IT Growth, both at around 13 per cent.
The growth portfolio has led the sector in terms of NAV total return over the past year, making 40.7 per cent, and 41.75 per cent in share price terms.
JP Morgan European IT Income has made 38.2 per cent in NAV terms and 41 per cent in share price terms.
Both trusts, however, have been weaker performers over three years, where Darwall’s trust leads the way with NAV gains of 70.5 per cent.
The five crown-rated trust has the best returns in share price terms over that time period and also over five and 10 years.
Although the trust is sitting on a slight premium of 1.46 per cent, it has been as high as 3.64 per cent over the past year and investors may think it is worth paying that premium for a track record so strong.
