Well, the storm of Eurozone disintegration that was threatening to engulf Europe has, it seems, abated for now. The decision of the French electorate to cast a resounding “oui” for Emmanuel Macron and a “non” to Le Pen suggests that the youthful President’s pro-European Union (EU) stance resonated. After the twin surprises of Brexit, and Trump’s election, we can chalk one up for the establishment.
But, actually, when one reflects on it, the commitment over the last several years that voters and policymakers have shown to European integration, as well as their ability to stave off a number of crises, has been quite remarkable. From the spiking of Periphery bond yields, through a looming Grexit, to the emergence of a wave of populist parties all clamoring for a breakup, Europe has managed to stand fast. Yes, Brexit was a blow of course, but the UK had never adopted the common currency, and it’s conceivable that the loss of a partner whose commitment was always somewhat wavering may actually end up strengthening the remaining bloc.
So, with the French election now behind us, it’s partly this removal of what was a critical source of uncertainty that has led our CIO Team to move to an overweight position on European equities (see Vive la France, long live Europe and its equities). Of course, political risks remain. We still have elections coming up in Germany in the fall and, perhaps more worryingly, an eventual resolution to the situation in Italy. But, even if the anti-EU Five Star Movement were to win that vote, it’s not clear that their path to a referendum (Itexit? Can you bear it?) would be a short or smooth one.
However, it’s not just the politics that have led the team to their call, far from it. There are in fact three other reasons why they believe that the case for Europe is strong:
Macro Stabilization – It’s worth reminding ourselves that European gross domestic product (GDP) actually outpaced the U.S. last year, growing at 1.8% versus the 1.6% we experienced here. Throw in some recent highs in consumer confidence, purchasing managers’ surveys, and The Ifo Business Climate Index index of German business expectations, along with some encouraging numbers on declining unemployment, and a return of some healthy inflation, and the European economic picture is starting to look a little rosier.
Earnings Growth – The team also noted a pretty robust start to 2017 earnings reports in Europe, with a first quarter that was the strongest in years by some measures. The result is that consensus Earnings per share (EPS) forecasts for this year are starting to get revised upwards for the region. Indeed, we are forecasting earnings for the Stoxx Europe 600 Index to grow by almost 11% over the course of the next year, and even that is relatively conservative compared to consensus, though there are no assurances that such forecasts will be achieved.
Valuations – Despite the strong start to 2017 that we’ve witnessed across European equity markets, relative valuations to the U.S. still look fairly cheap. Figure One shows the ratio of price-to-book (P/B) for MSCI Europe Index and MSCI USA Index. It’s shown as the European ratio divided by the U.S., so the lower the line the cheaper Europe is relative to the US. Since European book valuations have consistently traded at a discount over this period we’ve also added the average ratio. It’s clear that on a P/B basis, European markets are still attractively priced when compared to the U.S.
It feels like it’s been a very long time coming, but, we’d argue that the vital removal of a substantial degree of uncertainty that the French election has afforded, along with an improving macro and earnings profile, and the ability to access the region on relatively attractively priced valuations is all starting to speak to a re-evaluation of how U.S. investors should think about Europe.
As our colleagues in the CIO Team so eloquently put it – Vive la France!