He said this will be critical now that correlations are normalising, with consumer cyclicals the sector where he sees the greatest upside potential.
“Europe’s economy has stabilised and political risks have diminished,” said Bateman. “Equities enjoyed gains in 2013 as the risk of a eurozone break-up receded, yet valuations remain compelling and there is still plenty of upside. The next catalyst should be an improvement in earnings momentum, and a stock-picking approach will be needed to identify the winners.”
Potential Positives
Bateman’s view is that a number of factors have aligned to offer potential positive returns from European equities. The macro environment looks supportive, with the European economy having troughed and he expects positive GDP and earnings revisions going forward.
“Tapering in the US should have a minimal impact on European stocks but will be detrimental to emerging and US markets,” said Bateman. “Tapering will lead to the strengthening of the US dollar and will see the euro become relatively weaker, which will be a positive for Europe’s exporters. By contrast, emerging markets are likely to be negatively impacted by tapering, dollar strength and a reversal of yield chasing hot money flows.”
Monetary policy remains loose in Europe and the European Central Bank (ECB) has demonstrated that it is prepared to act decisively, said Bateman. “Recent lower-than-expected inflation has seen the ECB cut rates, but that is just one policy available. We note that, compared to other central banks, the ECB has a number of unused tools on hand to combat the risks of low growth and weak inflation.”
Restored Confidence
Bateman also believes the ECB’s Asset Quality Review in 2014 will restore confidence in the European banking system and put to rest fears of a eurozone banking crisis. “The risk of a European systemic banking crisis has virtually disappeared. The region’s banks have been unwinding and de-risking their balance sheets, and issuing equity. On aggregate, the sector’s capital position has improved markedly and is on course to meet new regulatory requirements ahead of schedule.”
In addition, Bateman noted that the risk premium in Europe is still at elevated levels despite the market appreciation. “Valuation of European equities remains compelling versus history and other equity markets around the world. European earnings are still some 30% below their peak, while US earnings have already surpassed their previous peak. We see scope for domestic European earnings to recover in 2014 as economies return to growth and activity picks up. There is still plenty of upside potential in Europe in terms of profit margin expansion.”
