It is perhaps stating the obvious that the European sovereign debt crisis has been largely to blame for the long period of uncertainty and volatility that has made investing in equities an uncomfortable and unrewarding exercise since early 2010, when the Stoxx Europe 600 was nearly at the same level that it is currently.
However, recently a number of strategists have pointed out that there may be more than a little light at the end of the tunnel for the European economies. Recent Purchasing Manager Index (PMI) surveys for both the manufacturing and services industries have started to clamber off the floor and expectations for a continued recession have been replaced by hope for a return to (at least tepid) growth in the latter part of 2013 and early 2014. As you will be bored of hearing, we have been forecasting positive output in 2H 2013 and decent growth in 2014 (2% European GDP).
Aftershocks
Ever since the shock of the 2008 financial crisis, chief executives all round the world have run their companies in a very conservative fashion, rightfully distrustful of the next “bazooka” of politically-inspired nonsense in the US and Europe that has derailed and delayed hopes of a sustained return to confidence.
In the US, this has led to the now oft-reported accumulation of trillions of collective dollars on company balance sheets, which have more recently found their way into investors pockets via increasing equity dividends, helping a sustained rally and outperformance of US stocks.
Since 2009 the US economy has been growing at a very moderate rate and this continued to be the case in the first half of 2013, which looks like it might ultimately come in somewhere between 1% and 2%. However, in the same period European companies have been battling with no growth at all and even less confidence than their US counterparts, as they have encountered continuous major sovereign and political crises.
Optimism
Some equity strategists are beginning to turn more optimistic about the prospects for European markets, anticipating that they will continue their recent recovery and close the substantial valuation gap that has opened up against the US market, which now sells for over 15 times 2013 earnings.
One substantial factor that may encourage outperformance in European markets would be if local companies could gain from improved conditions in their own economies. Admittedly, today so many companies are truly global that an improving European economy will likely benefit most international companies. However, any such improvement will be more advantageous to local European stocks, especially if peripheral economies like Spain start to see some economic pick-up.
European car sales are at incredibly depressed levels. In Italy, despite a population rise of 12 million since 1969, automobile sales are down at the same level they were in that year. Similar metrics apply in countries like Spain and even Germany, where the economy has generally held up much better than elsewhere but consumer confidence is still at depressed levels, as political uncertainty and fear of tax hikes to fund bailouts have held back consumer spending. A recovery in these markets would not just benefit the substantial number of European automakers, but also the many component and tyre manufacturers, a number of which are quoted on the European bourses.
Yet another crucial factor for a bottom up improvement in European markets is a continued increase in confidence in financial stocks. In the US, financials represent 18% of the S&P 500 whereas in Europe it is an even more important 22%, of which nearly 13% is the banking sector, compared with just 6.5% in the US. Recent results have encouraged investors to believe that banks are on the mend; yesterday shares in Commerzbank, which has had five capital raisings in four years, rose 16% as the company beat low expectations and management issued a more upbeat statement.
Risk remains
Clearly Europe is not without risk. If you fear a continuation of the political malaise that has dogged sentiment over recent years and also expect banks to be forced to raise more capital after their recent rally, then you probably wouldn’t rush to buy Europe. However, if you think that the recent improvement in economic data continues and that financially robust companies may echo the performance of the US in the last few years, then this may be the start of a period of sustained outperformance for European equities. Even if it doesn’t turn out to be a bright new dawn for Europe and the relative valuations mean nothing, then at least you know that value will ultimately be on your side.
