European equities have ample scope for further appreciation as the economic recovery gains traction and corporate earnings display long-promised improvement, Schroders’ Steve Cordell has claimed.
The manager of the £861m Schroder European Opportunities fund, recently renamed from Cazenove European, said the market had recently demonstrated encouraging resilience, registering gains in spite of political change in Italy, turmoil in Ukraine and a largely underwhelming earnings season.
Mr Cordell, a business cycle investor like other ex-Cazenove managers, said the manufacturing purchasing managers’ index (PMI) surveys are among the most important data points for gauging the stage of the cycle.
“February PMI surveys confirmed the eurozone economy continues to expand, albeit at a relatively modest rate,” he said. “We look closely at new orders, as these give a three- to six-month lead on where the revenue line in the manufacturing sector is heading.
“After the surge in PMIs since last summer, we would expect earnings upgrades to start coming through this year. In this regard, the UK appears slightly ahead of continental Europe and is close to shifting from peak cycle into slowdown.”
According to Mr Cordell, Europe’s earnings cycle has been depressed mainly due to austerity measures imposed in most major economies.
While earnings remain 30 per cent below their high point, he said US earnings had recovered much more quickly and already passed their previous peak.
“This is largely down to action taken by the Federal Reserve, whereas the European Central Bank (ECB) has not been so generous in its measures to support the economy,” he added.
“The ECB could announce further action if inflation remains substantially below target, although we believe the earnings cycle is set to improve anyway. There is plenty of earnings potential still to come, particularly in financials.”
Mr Cordell said the risk of bank defaults has receded, and he expects most to pass the ECB’s asset quality review of the sector.
The ECB is set to assess €3.7trn (£3trn) worth of assets from the biggest lenders in the eurozone across 128 banks.
The review will be followed by stress tests for eurozone banks in the summer. The results of both probes will be announced in October.
“Bank equities remain relatively depressed compared to the improvement seen in the credit market, so there is scope for them to play catch up,” he said.
On the political side, markets seem to have welcomed the recent change of government in Italy amid hopes new prime minister Matteo Renzi will reinvigorate the reform process.
“Barring major geopolitical shocks, stock-specific factors look set to be the main drivers of European share prices in the coming months. With the European economy still in its expansion phase, earnings momentum remains the key factor determining share price performance,” added Mr Cordell.
“Most recent downgrades have been due to foreign exchange rates, and this has resulted in domestically exposed European stocks outperforming globally exposed peers. This trend is likely to continue as long as concerns remain over the outlook for emerging markets.”
