Investors shouldn’t give up Europe despite political uncertainties as there remains genuine stock picking opportunities, according to the experts.
European equities have been a mixed bag this year, outperforming UK equities for the second year in a row and the fourth year in five, but lagging global equities generally.
While the UK’s decision to leave the European Union and the Italian referendum ‘no’ vote have cast a cloud of doubt over the region, the MSCI Europe (ex UK) has returned 16.43 per cent over the course of 2016.
Performance of indices in 2016
Source: FE Analytics
However, this is 11.93 percentage points behind the wider MSCI World index and with upcoming elections in Holland, France and Germany on the ticket for 2017, as well as the fallout from the Brexit vote in June, investors could be forgiven for being cautious when it comes to European equities in 2017.
Below, FE Trustnet looks at what the experts think of the prospects in Europe for 2017 and where they see the best opportunities heading into what will likely be another turbulent year.
Invesco Perpetual – “Get a grip - for all its issues, Europe isn’t that bad.”
Jeffrey Taylor, head of European equities at Invesco Perpetual says the region is by definition complicated and often confusing, especially for people from other parts of the world.
“European equities have had a volatile 2016, pulled around by investor concerns around growth, the banking system, politics, deflation and earnings,” he said.
“As so often with this asset class, the market’s perceptions can be out of sync with what is really happening on the ground.”
“When the continent’s complications cause the kind of outflows from European equities seen in 2016, and European equities become as unloved as they appear to be now heading into 2017, there can, conversely, be significant opportunities to exploit for investors like us who are willing to take a long-term view and overcome the vagaries of market noise.”
Indeed, Europe ex UK and Eurozone equities are re-testing the highs in equity risk premium for the first time since the financial crisis.
But Taylor says Europe has proven itself to be remarkably resistant to global macroeconomic turbulence in 2016 and a continuation of the modest but respectable economic recovery that the Eurozone is seeing is his base case for 2017.
“Continental Europe went through a good many years of under-consumption and under-investment thanks to the region’s successive crises: Now it’s catch-up time,” he said.
Meanwhile, earnings, which have been a constant source of disappointment in recent years, have been overblown and expectations are now too low, he adds. 
“The good news is that analyst expectations are now extraordinarily low; in fact, they are more in keeping with a recessionary environment for which we currently see no justification.
“In an environment of positive GDP growth with inflation creeping higher, cyclically low margins making positive operating leverage logical, and falling financing costs, we would not be surprised to see positive earnings surprises out of Europe in the coming quarters.”
Miton – “It’s not easy to be positive on the European economy, but there is no shortage of strong company growth stories.”
Carlos Moreno fund manager of the CF Miton European Opportunities fund, disagrees with Taylor, noting that the European economy is likely to remain sluggish, with little inflation next year.
With the working age population declining, productivity growth on a long-term downtrend, credit demand weak and investment levels low, the macro environment remains challenging.
However, he says there remains a number of good quality companies that investors should not overlook because they are domiciled in Europe.
“As stock pickers (not economists) we aim to run an economy balanced fund. We look for quality businesses whose best days are ahead of them,” he said.
“They are characterised by pricing power, high returns on capital, big competition ‘moats’ and substantial potential to grow volumes and expand margins.
“We like companies that are expanding globally from a European base, yet which trade at a substantial discount to their intrinsic value. Many of these names are medium sized and we will continue to have a substantial mid cap bias.”
He adds that family-run businesses –common in Europe – tend to be run for the longer term and offer a number of the attributes mentioned above, with sports car maker Ferrarri a “top three play” in 2017.
Columbia Threadneedle – Geo-politics to take centre stage
Mark Burgess, global head of equities at Columbia Threadneedle, says regardless of the economic environment in the region, geo-politics will remain the key theme in 2017 for investors to navigate.
The most pressing issue is the upward trend of support for European populist parties, he says with the Dutch, French and German elections to name but a few European political events taking place next year.
“The potential for political instability in Europe is rife with a number of elections and referendums in 2017,” he said.
“If there were to be a move toward populism in any of these countries, there could be destabilisation of an already fragile economy if a significant member state were to leave the single currency.”
This has been kicked off by the resignation of Italian Prime Minister Matteo Renzi after an overwhelming majority voted against the recent referendum he proposed, throwing Italy into uncertainty at a time when its banking system is particularly vulnerable, he adds.
Also worth watching is the US markets, which have become increasingly important for Eurozone exporters, so changes in Trump’s stance on international trade could impact Europe too.
Neptune - Value’s recovery in Europe can continue in 2017
After many years of underperformance, value in Europe has had a resurgence in recent months, outperforming quality growth since the beginning of the summer.
As the below graph shows, the MSCI Europe ex UK Value index has outperformed its growth counterpart by 8.27 percentage points in 2016, with much of this outperformance taking place since September.
Performance of indices in 2016
Source: FE Analytics
Rob Burnett, manager of the Neptune European Opportunities fund, says the key for value to continue outperforming is for rates to stop falling, something which is beginning to be priced in by the markets.
“There has been a definite change in attitude from policy makers in recent months,” he said.
“Since the financial crisis, the core approach to stimulate growth has been cutting interest rates and quantitative easing (QE), which further pushes down rates. In some cases, yields have even turned negative.
“Central banks are now learning that there is a limit to how much rates can be cut without it damaging the economy, the so- called “reversal rate” as it is known in academic literature. We are perilously close to this in Europe today and so the probability of further cuts is low.
“While the stabilisation of rates has proved to be the catalyst for value, it is the scale of today’s valuation support for certain companies that should enable prolonged outperformance in Europe.”
Additionally, he says history is on value’s side, given the long period of underperformance for the investment style.
“It is understandable that investors in Europe remain wary of value strategies given both the volatility and the degree of underperformance in recent years.
“But it is this tough period that has provided an excellent long term entry point. We believe the value recovery is set to continue, and will reward those investors who capture this opportunity in 2017 and beyond.”