Europe ex-UK has persistently underperformed broader global equities in dollar terms since the financial crisis (as shown in the chart below) – largely due to the combination of low economic growth, lacklustre earnings and political concerns. While this has given Europe a relatively cheap valuation against international markets, the region has lacked a catalyst to realise its value.
Source: Bloomberg, as at 10/04/2017. Y axis represents the ratio between MSCI Daily TR Net Europe ex-UK USD Index and the MSCI Daily TR Net World USD Index.
We believe the first of these issues is changing, as the economy is showing signs of acceleration through improving business and consumer sentiment. Not only are businesses feeling positive about the future, with the Eurozone Composite PMI accelerating to 56.4, but consumers are also more optimistic – with consumer confidence data rebounding from relative lows set in early 2016. While we have seen Germany do a lot of the heavy lifting in the past, the recent acceleration has been more broad-based – with Italy, France and Spain taking up more of the slack.
Source: Bloomberg, as at 10/04/2017. X axis represents Eurozone Composite PMI (LHS) and the Y axis represents Consumer Confidence (RHS).
Improving economic data has seen earnings estimates revised upwards, with the blended forward 12-month EPS estimates rising by more than 6% in the past six months. This implies positive earnings growth should be about 19% this year, which should provide a strong valuation catalyst relative to the MSCI World index, which offers weaker earnings growth.
So what is the catch? As is often the case in Europe, political risk is an important factor. While markets were calmed by the victory of incumbent Mark Rutte in last month’s Dutch election, the focus is now on France. This is by far the biggest political event in 2017, with the German election later in the year seen as less of a risk – given the positive stance towards the European project from both Chancellor Angela Merkel and leading challenger Martin Schulz.
With early favourite Francois Fillon’s fall from grace, it looks likely we will see Emmanuel Macron and Marine Le Pen facing off in the second round of the French election. Macron is seen as the progressive candidate, who would be positive for the market. Le Pen, on the other hand, is seen negatively by the market, as she would bring more uncertainty to the region. Whilst a win wouldn’t guarantee her a majority in parliament – and could prove to be another roadblock to her anti-euro agenda – markets would likely fall on the increased risks and uncertainty she would pose.
Taking these risks into account, we are happy to be currently overweight Europe ex-UK, as it demonstrates all of the usual characteristics for outperformance – a relatively cheap market that has underperformed, as well as strong EPS growth and improving economic data. We believe Europe is poised for outperformance for the rest of 2017.
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Fund Manager’s Assistant
CLI00736 Expiry on 13/04/2018