Michael Barakos, Chief Investment Officer, European Equities, JP Morgan Asset Management
The argument that European equities look cheap on a relative basis – which was true for the last six years, during which time European equities returned more than 200% in absolute terms via dramatic re-rating – can no longer be made. At these levels, European equities look closer to fair value, neither cheap nor expensive.
That is why now is really the ‘show me’ time for the market. We’ll need to see earnings growth materialize in order to move sustainably higher.
Having mirrored US corporate earnings for decades, during the last five years European earnings have significantly lagged as US growth has powered ahead. However, that has now started to change, which bodes well for the market outlook. In fact, we’ve recently seen more positive upwards revisions to aggregate European corporate earnings estimates for the first time since the summer of 2011.
Promisingly, macro-economic headwinds are turning into tailwinds. There is a litany of positive catalysts:
- The collapse in the oil price that helps lower input costs for European companies and increase disposable real incomes for consumers, acting as a significant boost
- The significant decline in the Euro bolsters European corporate competiveness
- A spate of strong eurozone economic data continues to exceed expectations, leading analysts and policymakers to upgrade their estimates for GDP growth. Real-time eurozone PMIs are solid evidence accumulating of a turn in the euro area’s growth momentum
- Deflation fears have troughed and eurozone inflation expectations are recovering (from a low base)
- Credit is expanding and flowing more freely — not only are banks making it easier to access bank lending, but demand for loans from both households and businesses is on the rise
- Consumer confidence is rebounding and sentiment is improving, concerns about Greece notwithstanding
These tailwinds are being felt by European corporates. From a pan-European earnings picture of no growth at all for the last 5 consecutive years, we are now seeing estimates for 5% earnings growth. And that headline number actually masks powerful underlying growth at the sector and country level.
For example, if we exclude the energy sector, which has been dragged down by the falling oil price, aggregate earnings growth estimates rise to 10%. If we further strip out other areas struggling with idiosyncratic issues, such as Switzerland grappling with the dramatic Swiss franc appreciation, the estimates climb even higher to nearly 15%. And those estimates continue to be upgraded.
Importantly, it is the rate of change in growth expectations – rather than the absolute growth levels themselves – that invariably dictate and drive stock market momentum.
As we look for corporate earnings to finally deliver on the improving business landscape, a selective approach to finding the best investment opportunities is critical.