An opportune time to change investors' perception of investing in Europe

Ridhima Sharma
An opportune time to change investors' perception of investing in Europe

A healthy European economy seems to have stirred the interest of investors again. For the first time since the 2008 financial crisis we’ve seen evidence of synchronised euro-area gross domestic product (GDP) growth. Investors don’t seem to be focusing on individual growth in standout countries like Germany and the Nordics for example; now we’ve seen evidence of balanced economic growth in countries such as France and Italy, too.

Gross domestic product growth in the euro area has quietly overtaken that of the United States so far this year. But the risks once associated with political uncertainty, populism and fears over the possible breakup of the European Union (EU) have not proven as potent as they initially appeared. As a result, we’ve seen a political risk discount for EU stocks, which we expect to translate into potential upside growth for companies in the region. However, we don’t expect this political-risk discount to continue much further.

In our view, a less-uncertain outlook in Europe and attractively priced European shares present an opportunity for some investors to change their perceptions about investing in EU countries.

Stocks in the energy and financials sectors appear attractively priced to us. Banks and insurance companies in particular could offer opportunities for investors. Relatively cheap valuations and declining market pessimism about the price of oil could benefit the energy sector in the short term.

While we’ve seen some good opportunities in Europe, we think the weak US dollar represents perhaps the biggest headwind for European equity markets right now. Companies that have a large exposure to the United States and report in euros could suffer from foreign exchange translational effects from the weak US dollar. Areas that might be most affected by a weak US dollar include industrials, chemicals and the automobiles.

The Bigger Picture
It’s important not to forget what sets the backdrop for European equity markets—European Central Bank (ECB) monetary stimulus—even as rumours swirl around the ECB’s plans to taper its asset purchasing programme. We expect the ECB to announce its tapering plans over the coming months and expect tapering to be put in action over the first half of 2018.

However, if the ECB were to move more quickly—or indeed more slowly—than expected, we’d expect European equity markets to be impacted. A slower tapering plan would likely weaken the euro, but if the ECB tapered off more quickly than expected, it could strengthen the euro and put additional pressure on the equity market. European exports to Asia and the United States would be put under pressure, which would in turn be mirrored in underperformance by European exporter stocks.

The US Federal Reserve (Fed) has previously served as a model for tapering its unconventional quantitative easing policy. So while it’s important for the ECB to taper at some point in the future, it shouldn’t be an issue for equity markets as long as there are no surprises that deviate from the language ECB members or monetary policy minutes have previously hinted at.

Our base scenario is the ECB will follow the script—we don’t see any reason at the moment that the ECB would switch to a more hawkish tone and accelerate tapering.

Robert Mazzuoli, portfolio manager, Franklin Local Asset Management, European equities

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