European equities were in high favor last year. The region had overcome
the 2012 sovereign debt crisis and was finally seeing an economic boom - complete
with its own hashtag, #Euroboom.
Some of that enthusiasm has waned since. European stocks still failed to
match Wall Street gains, rising just 1.3 percent this year, after surging 10
percent in 2017 .STOXXE.
More ominously, a string of economic data has raised doubts that
corporate profits will keep rising. That has knocked the index 4.2 percent off
January highs and some $19 billion has fled euro equity funds in the past seven
weeks, data from EPFR shows.
Funds’ allocations to euro zone equities dropped to a 13-month low in
April, according to Bank of America Merrill Lynch, which says “overweight”
positions have slipped to 34 percent versus 58 percent last October.
Kevin Gardiner, global investment strategist at Rothschild Wealth
Management, is among those disillusioned with the market.
“If Europe didn’t do well last year, when is it going to perform?” said
Gardiner, who recommends neutral positioning on continental Europe.
His disappointment is perhaps understandable.
After picking up strongly most of last year, IHS Markit’s flash PMI
survey - a key euro zone manufacturing activity gauge — dropped to 14-month
lows of 55.2. Business confidence in Germany, the bloc’s growth engine, fell
this month to the lowest in over a year.
In a sign analysts were unprepared for such a slowdown, Citi’s economic
surprise indicator for the euro zone has fallen to its lowest since June 2012
.CESIEUR.
If data due on Wednesday shows first-quarter economic growth
decelerating significantly from the previous three months, that could be a
crucial negative signal for the market, bears say.
KEEPING THE KETTLE ON THE BOIL
Not so fast.
Some investors are sticking to their guns - they say economic
indicators’ decline from the supercharged levels of last year was to be
expected.
“It was kind of too good to be true in that you had PMIs in Europe near
60, which was great and you were thrilled with it and you would take it but ...
you just didn’t really feel all that comfortable with it,” said Daniel Morris,
senior investment strategist at BNP Paribas Asset Management.
“The higher you go the further you fall, so I think it’s made the
decline since seem worse than in fact it really is,” said Morris, who remains
“overweight” on Europe.
Another investor, Chris Dyer, director of global equity at Eaton Vance,
is keeping European equities as his largest “overweight” within global
portfolios, noting that the indicators had hit multi-decade highs last year.
“It’s hard to keep the kettle on the boil for that long, so I’m not too
concerned about it coming off,” Dyer said.
The reason for clinging on, investors say, is their belief that regional
companies will still deliver robust profits. In 2017, European firms enjoyed
their first year of earnings growth in seven years and MSCI Europe should
deliver earnings growth of 7.5 percent this year, according to Thomson Reuters
I/B/E/S.
This pales in comparison with the 19.8 percent predicted for the S&P
500, but U.S. earnings are widely seen as boosted by hefty tax cuts.
In the first quarter, MSCI Europe earnings are expected to grow 0.6
percent from Q1 2017 in euro terms - which translates to a healthy 12.1 percent
in dollar terms, as the euro appreciated sharply in the first quarter.
Finally, the euro zone’s newfound political stability is also reassuring
investors, after populist, euro skeptic parties largely failed to make much
headway.
The best example of that optimism may be Italy. Italian stocks are among
the best performers globally, gaining 9.7 percent year-to-date, led by banking
stocks that are well positioned to benefit from growth. That’s despite the
likelihood of fresh elections after an inconclusive vote in March.
“The fact that Europe is on a sounder footing and that growth seems to
be relatively well-underpinned ... we’re pretty comfortable with
that,” said Alistair Wittet, manager of the Comgest Growth Europe ex UK
fund.