Market Memo: European equities ride the tailwinds

05-15-2017

The Brexit rupture aside, Europe now looks to be in better shape than it has for some time. Underpinned by an accelerating recovery, relatively low interest rates and an improving labor market, GDP growth should reach 1.75% this year. Even France, long the sick man of the continent, generated 0.3% growth in this year’s first quarter. With an overwhelming relief victory in the critical presidential election by the pro-European establishment, France has given investors a moment of optimism—there appears to be life left in liberal Democracy.

These brightening economic and political scenarios already are being reflected in accelerating earnings. Of the 71% of European companies that have reported first-quarter earnings, 67% beat earnings-per-share (EPS) estimates, surprising positively by 11% and delivering 24% year-over-year (y/y) EPS growth—the strongest growth in nearly 7 years. Ex-energy EPS growth was even better, up 17% on broad-based improvement—nine sectors reported growth, with the top-line up 12% y/y as 79% of companies beat estimates.

We believe these strong earnings presage a very good year for European equities. With improving economic and political environments and relatively low earnings comparisons to beat over the next several quarters, they have the wind at their backs. This robust recovery in European equities also underscores the benefits of a long-term, patient value investing strategy—one predicated on the notion that high-quality companies massively out of favor with the market eventually should see the market’s perceptions of their value reverse. The timing of and catalysts for this change may be unknown, but history suggests the benefit of this approach will be borne out over time.