A year ago, amid widespread scepticism, we argued for a renaissance in Europe. In 2017, the eurozone recorded its fastest rate of economic growth in a decade, confidence soared and stocks rallied. Today, Martin Todd, Co-Manager, Hermes European Alpha at Hermes Investment Management, revisits the case for European equities and asks: is the future still bright for the region?
Europe entered 2017 against a backdrop of political uncertainty. Many investors feared anti-establishment electoral threats as the region braced for a slew of high-stake elections in the UK, Germany, the Netherlands and France.
At the same time, we argued in favour of European equities in our commentary, “Why European equities?” The central premise was that the market provided attractive opportunities given that negative sentiment overshadowed the region. We also highlighted that companies are not the economy or the politics of any nation.
As we stated in February 2017:
“Weak sentiment provides great opportunities for stock pickers such as ourselves. As the market focuses on the enduring economic and political problems in Europe, opportunities for other investors to identify resourceful, innovative and growing companies will persist.”
Indeed, investors’ overt focus on political and economic uncertainty in Europe overlooked the solid progress of corporates, and created a clear valuation anomaly. Following a robust year in Europe, we believe it is an appropriate time to revisit some of the key points we made a year ago:
Economic growth is expected to remain strong. Despite eurozone unemployment dropping by 1.1 percentage points over the last year, it still remains at 8.7%, providing considerable slack before inflationary pressures kick in3.
Furthermore, corporates are undoubtedly more constructive on the outlook, particularly in cyclical sectors. Synchronised global growth is supporting demand, inflation remains subdued, funding conditions are easy, all of which is providing corporates with the confidence to invest. This flows through to earnings, where in 2017 European companies broke the decade-long downgrade trend to generate growth of approximately 13%. Despite the stronger euro (the one headwind against our original thesis), we still anticipate 9-10% earnings growth in 2018, broad-based across both industries and countries.
The looming Italian election in March will dominate headlines and intransigence is likely to be the over-riding theme as Brexit negotiations continue. However, investors are starting to recognise that political events are not structurally impacting the health of the economy or the markets.
The outlook is still bright
Although challenges remain in Europe, the turnaround is striking. At Hermes, we believe the economic improvement has plenty of room to run. As long as investors continue to quibble over European elections or macroeconomic data, we see opportunity. After all, everybody knows that it is prudent to sell amid euphoria. And that is a long way off in Europe.