30 March 2017
Optimism on the corporate earnings outlook in Europe for 2017 has become more consensual than contrarian recently, and with good justification. Macro-economic data from the Eurozone, especially France, is more buoyant than it has been for many years and the global demand environment continues to offer support. There is the perennial political noise, of course, but it is worth remembering that rising markets always climb a wall of worry. The key risk in 2017, namely, that the French Presidential election will deliver a candidate committed to “Frexit”, still looks, on balance, unlikely.
The European market now trades on a forward earnings multiple of 15x. This is below the US at over 18x, but also above its long-term average of 13x. Analysts, whilst typically somewhat over-enthusiastic at the start of the year, now expect 14% earnings growth in Europe in 2017. In this unfamiliar context of elevated expectations, it is more important than ever for investors in European equities to ask themselves whether a rising tide can really lift all the boats in their portfolios. Our own view is that the “reflation trade” is likely to be more discriminating in the remainder of 2017 than in the final quarter of 2016.
We are particularly circumspect on the generalized investment case for the European banking sector. Returns on assets are closer to peak than trough levels, and the reduction in leverage in the system required by regulators has had a permanently depressive effect on achievable returns on equity. There is a paucity of loan growth and given the amount of spare capacity in Europe, the move in long-dated interest rates may prove short-lived when the inflationary tailwind from higher oil prices ebbs away later in 2017.
Investors should seek upside cyclical exposure with more credible fundamental foundations as this is more likely to yield outperformance even if wider market expectations prove optimistic. Materials stocks are still not discounting the positive price action in commodities markets and the Chinese government appears committed to further economic stimulus through fixed asset investment. Domestically, certain building materials and media stocks, having survived a prolonged recessionary period, are now well placed to benefit from an upturn in activity and there are far fewer regulatory, competitive or valuation hurdles for investors to overcome.
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The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.