After years in the doldrums, European stocks seem poised to break out of their trading rut and possibly outperform the U.S. equity market this year.
Eurozone politics and sluggish economic growth have not been kind to European stocks in recent years. While the S&P 500 has breached new all-time highs every year since 2013, European equities are yet to reach previous peaks, let alone surpass them1. Yet there’s reason to believe that 2017 could be the year when the eurozone’s major equity markets turn the corner.
Political discontent still poses a risk, says Matthew Leeman, who heads up MSIM’s European Equity Team. But the risks are largely priced in, he believes, and there’s hope that support for anti-establishment parties may be cooling. “For once, European politics could be seen as a tailwind and not as a source of volatility,” he argues.
Leeman gave clients at MSIM’s recent Global Investor Conference five reasons to be optimistic about European stocks this year:
Global Growth forecasts have been revised upward,2 and that’s good news for European exporters and multinationals. In the U.S., the Trump administration has pledged to stimulate economic growth through fiscal expansion and infrastructure. Economies of certain countries in the emerging markets, namely Brazil and Russia are stabilizing3 and the eurozone’s economic outlook is also improving,4 with leading economic indicators pointing to 1.4% GDP growth for the region in 2017.5
The continued weakening of the euro is also a positive, as roughly 45% of European earnings come from outside the European Union6. As a rule, every 10% weakening of the euro can translate to 6% earnings per share growth and 1.1% to the nominal GDP in Europe, says Leeman.
“Given the significant spread between U.S. Treasuries and German Bunds, it is very likely that the euro will continue to remain weak, thus boosting European exports," he adds.
With the European Central Bank extending its quantitative easing to December 20178, albeit at a slower pace, interest rates in the eurozone should remain low for longer. “There is still an abundance of liquidity in Europe,” says Leeman. “We expect this to further spur growth across the EU."
Developed markets inflation is expected to move towards and in some cases above, central bank targets10, given the large year-on-year increase in commodity prices through the first quarter of 2017.
“The bottoming out of inflation expectations is a significant step forward, as it reduces deflationary fears,” says Leeman. Equities also tend to be a natural inflation hedge, because rising inflation increases corporates’ pricing power. Equities usually outperform fixed income securities when long-term bond yields start to climb in reaction to rising inflation.
Most importantly, European corporate earnings have probably bottomed out, after sliding for six years. Companies began to show signs of recovery in late 2016, when earnings per share turned positive for the first time in 16 months.
“The turn in commodity prices, improving profitability in banks, the weak euro and rising inflation expectations all point to better top-line growth and higher margins," says Armandola. “We believe that high, single-digit growth in earnings appears to be realistic for 2017."