Market Memo: European equities ready to rally?

04-05-2017

Optimism over European equities has been a long time coming. A drawn-out period of economic stagnation following the global financial and sovereign debt crises offered good reason to be wary. While S&P 500 earnings have climbed over the last five and 10 years, earnings in international developed markets had been basically flat.

There’s no question that austerity programs in the eurozone have significantly dampened demand. Banks, the engine that drives economic growth in Europe, have been sitting idly by while they restructure, using their excess capital to reserve against nonperforming loans and/or shoring up capital levels. As a result, European banks experienced negative loan growth over the last five years. Likewise, deleveraging has been the focus for governments, corporations and consumers. This period of austerity coincided with a period of unprecedented monetary stimulus, with international central banks keeping interest rates at zero and in some cases negative levels. 

Signs of a comeback
We are now starting to see demand return as the three legs of the economy—governments, corporations and the consumer—are starting to spend. Economic numbers in the eurozone have shown steady improvements over the last six months. Manufacturing and service PMI numbers are at levels not seen in over 10 years. Unemployment numbers are falling, auto sales are increasing and banks are experiencing slight improvements in loan demand. This sets up a virtuous cycle with potential increases in international equities due to not only earnings growth, but also from expanding P/E multiples. 

Political risk remains a wildcard in the European equity forecast. Presidential elections this year in France and Germany will place pressure on investor sentiment. Geopolitical risks continue to overshadow. Still, year-to-date the European market is outperforming the S&P. And with U.S. indexes at fair to stretched levels, investors are looking for markets that have positive earnings growth with reasonable valuations. By just about any valuation metric, European stocks look attractive. At this early stage in its economic recovery, Europe looks set to present investors with the nudge they need to bring their international allocations back in line with long-term averages.