While there are signs of economic recovery in the eurozone, judging from falling unemployment figures and the threat of deflation seemingly abating, Larner said the levels of progress made across the individual countries are uneven.
Germany and Spain, for instance, both report healthy unemployment figures and expanding economic activity. France and Italy, on the other hand, continue to struggle with job creation and reviving a blistered banking sector, respectively.
“With some of the stronger economies’ business cycles maturing, there remains significant risk that the recovery will stagnate if growth in the weaker economies fails to accelerate,” he said. “We note that structurally lower productivity growth, adverse demographics and generally high private and government debt levels remain secular headwinds across the region.”
Coupled with the “highly elevated” political risks in 2017 in the form of several crucial elections, Europe has “less scope” for a US-style “great rotation” from bonds to stocks, Larner asserted.
And the European Central Bank’s recent monetary policy decisions, including reducing its bond purchases, has negatively impacted sentiment toward European sovereign bonds.
Larner stated: “Although the ECB will continue to provide support to European sovereign bond markets, the yields of core European countries’ sovereign debt (Germany and France) remain extremely low, and negative in safe haven short-term issues. As such, and with European political risk highly elevated, we do not believe that European sovereign debt offers value to longer-term investors at present.”
However, sovereign bonds can be a desirable hedge against episodes of risk aversion, and will remain useful in diversifying balanced multi-asset portfolios, Larner’s report said.
Though the ECB’s meddling may have not had the desired effect on European sovereign bonds, corporate bonds, particularly high yield, still appear attractive to Larner.
“European corporate bond markets have fared better in recent months, buoyed by improved global economic expectations. Within these, the high yield space has shown the greatest resilience, largely as a result of rising longer-term yields benefitting the stricken financial sector and higher industrial commodity and oil prices benefitting the materials and energy sectors, respectively.”
Larner is also similarly pessimistic on European equities, despite the fact they are trading at a significant valuation discount compared with US stocks. But he believes savvy investors can take advantage of such relatively low valuations.
“Although we are not overly optimistic on the prospects for European equities at this point, relatively low valuations can provide opportunities to acquire assets that may have lesser exposure to risks affecting the entire market,” he said. “Likewise, some businesses will be able to profit more greatly than others over potential positive reforms that could be implemented and at times of stress such as these, forward-looking, longer-term investors who can identify areas where such developments are likely can derive significant value.”
Larner also concedes it is possible for some inter-sectional rotation to occur, with rising oil prices and widening differential between short and longer-term bond yields providing a boon to the energy and financial sectors, respectively.
