Investors should overweight European equities in the face of increasing economic stability in eurozone and a looming uptick in earnings, according to Luca Paolini, chief strategist at Pictet Asset Management.
Europe has dominated headlines, mostly for the wrong reasons, over the past few months with the possibility of a break up the eurozone prompted by a Grexit seemingly becoming ever more likely and making stock markets rapidly tumble.
It was just a few months before this at the start of the year that the news was markedly positive, when the European Central Bank (ECB) announced a €1trn quantitative easing programme to stave off deflation, promote investment and spark economic growth.
According to FE Analytics, the index is still up 8.36 per cent over the year to date while the average fund in the IA Europe ex UK sector has returned 10 per cent and every member is in positive territory. Funds such as Argonaut European Enhanced Income and GLG Continental Europe have doubled the average return in the sector.
Performance of funds, index and sector in 2015
Source: FE Analytics
The Greece-led deadlock has thawed in recent weeks with emergency measures such as the closure of its stock market and banking restrictions lifted this week, sending Greek stocks plummeting down as seen below. Paolini says this has prompted the group to overweight European stocks across all their portfolios.
Performance of index over 1 month
Source: FE Analytics
“The allure of European stocks has increased now that Greece and its creditors are progressing towards a new bailout deal that should keep the country in the eurozone,” he said.
“As the uncertainty surrounding Athens has lifted, a more positive light is shining on the region while valuations have become more reasonable following the correction of the past few months.”
“Economic growth is resilient, led by a recovery in debt-laden countries such as Spain and Italy, which has made up for economic weakness in Germany. This is supporting corporate earnings in the eurozone.”
Our data also shows that Europe has become very popular with fund managers running global mandates.
The average weighting to Europe ex UK in the IA Global sector has seen a sharp uptick last month from 13 per cent to 30 per cent, reflecting that now two-thirds of the 271 funds in the sector have an overweight position.
Paolini says while companies are generally expected to see high single-digit earnings growth, Pictet believes earnings could be set for even more robust numbers thanks to a renewed confidence in the ongoing recovery.
“Earnings are expected to grow 7.7 per cent this year but our models suggest they could accelerate even further. Much of the recovery has been attributable to strong household spending, reflecting improved consumer confidence,” the strategist said.
“Business spending growth remains muted but the European Central Bank’s latest bank lending survey is encouraging with reports that credit standards on loans to companies have continued to ease, and that a net 13 per cent of banks reported an increase in demand for corporate loans up from 1 per cent in the previous quarter.”
“Our proprietary monetary conditions indicator shows that credit conditions in the eurozone are at their most stimulative in at least 20 years. These improvements suggest the ECB’s monetary easing policies are succeeding.”
David Madden, market analyst at IG, says while Greece’s stock market plunge was dramatic, it in effect showed a positive step towards the end of stagnation in European equities since concerns ramped up in April and should help European equities continue the progress made since the start of the year.
“The re-opening of the Greek stock exchange triggered an exodus from the Athens markets, but the rest of continental Europe took it as a step in the right direction. The Greek stock market was always going to have a dreadful time whenever it opened again, but it is an indication of confidence that the exchange can be opened at all,” he said.
Tim Crockford, co-manager of the £186m Hermes Sourcecap Europe Ex UK fund, is expecting monetary policy to remain loose, boosting consumer demand and business confidence.
“While there are still hurdles to overcome in the Greek situation, we are encouraged that the market is moving on from the drama that has been dominating the news agenda,” he explained.
“This will allow investors to focus on the recovery that is happening – and accelerating – in Europe. There has been a rash of positive news across Europe in recent weeks, which has been masked by the Greek headlines.”
He adds that car sales data for June show yet more signs of acceleration in some of the largest European countries such as France and Spain while European airline traffic rose 4.9 per cent in May.
However, despite the positive numbers not everyone is so sanguine with the analyst team at Roubini Global Economics recently saying the eurozone is in the middle of a weak cyclical rebound with plenty of near-term threats abounding as well as a host of longer-term problems remaining.
“Even with the immediate threat of ‘Grexit’ averted, downside risks remain and a broader structural recovery remains elusive,” the team said.
“For the latter, the authorities would have to do much more to support aggregate demand. As such, we expect the European Central Bank will continue quantitative easing beyond 2016 and see the euro continuing its downward trajectory against the US dollar at a moderate pace.”