“As evidenced by a massive trade account surplus of 4.5% of GDP, which is twice as high as in previous decades, Europe has gone through a period of major savings efforts over the past five years. Governments reined in fiscal deficits, especially in the periphery, while high unemployment put consumer spending under pressure and companies continued to cautiously deploy CAPEX.
“Europe has been one of the most job creative geographic zones over the past two years – turning the corner with GDP growth accelerating to 2.5% and thus returning to pre-crisis levels of economic growth for the first time.
“On the corporate front, 2017 marked not only the first year of aggregate sales growth since 2012, but also particularly strong growth. At +6%, it represents the fourth strongest annual performance since the turn of the century. Profits in the energy, mining and financial sectors recovered from record low levels, while aggregate EPS growth for Europe rose to over 20%, which was widely anticipated by the strong rotation towards financials and cyclicals in late 2016.
“In the UK, the rise in inflation, the first hike in interest rates since the financial crisis and a softer property market are creating worries about Great Britain’s weaker economic growth. The negative impact on the pound and the UK stock market has been exacerbated by the lack of progress towards a benign Brexit. As a result, the total net return of the MSCI Europe in 2017 lagged significant aggregate earnings growth. Valuations came down substantially throughout the year 2017 as the P/E LTM of the MSCI Europe declined by 10% to 18.8x.
What to look out for in 2018?
“European equities present a compelling investment case for the upcoming year. Although a lot of political uncertainty ended in 2017, Brexit is likely to remain a headache. Strong corporate and consumer confidence point to solid economic growth in Europe driven by domestic forces as well as a recovery in emerging markets – now equally significant as an export market for both Europe and the USA.
“Strong corporate and consumer confidence creates a favourable context for corporate earnings growth. In a marked change from the past 10 years where earnings consistently disappointed, earnings revisions have recently turned positive. There is a consensus expectation for a potential increase of +10% in 2018, a rate above the historic long-term average. Valuation seems reasonable at 14.8 NTM earnings.
“The outperformance of growth versus value in 2017 was less pronounced in Europe than in the rest of the world. The US and emerging markets’ high exposure to the FANGs and BATs, and their generally high IT exposure, has been the major driving force for performance in these markets. In contrast, the upswing has been broader in Europe. If there are any setbacks for these stocks, European equities may prove less vulnerable and more defensive due to their lower benefit from these stocks.”
Franz Weis, portfolio manager at Comgest
