Buzz builds over contrarian Europe allocations

Buzz builds over contrarian Europe allocations
 European equities: Sales vs performance

A growing number of analysts and managers are looking to European equities as a surprise pick for 2017, backing corporates to buck the trend of recent years and deliver healthy earnings growth.

The opening weeks of the year have seen a number of companies on the continent report strong fourth-quarter earnings, supporting a growing cohort of European stockmarket bulls.

Improving economic data in the eurozone has been accompanied by strong earnings forecasts for European companies this year. These predictions are renowned for their overconfidence – analysts predicted 7 per cent earnings per share growth for 2016 despite earnings eventually contracting by 1 per cent. But the starting estimate for this year is much higher, according to JPMorgan Asset Management, at 14 per cent.

Sentiment on earnings may be more reliable in 2017 according to Karolina Noculak, Aberdeen multi-asset investment strategist. She said the proportion of analysts expecting upwards revisions was now at its highest level for “many years”.

“Lofty expectations at the start of the calendar year are not new...however, fundamentals are starting to improve and there are signs of improvement in European earnings per share,” said Ritu Vohora, investment director at M&G.

Global fund managers concur with growing optimism for Europe. Allocations to the eurozone represented the biggest positive allocation change in Bank of America Merrill Lynch’s January survey. Markets are also catching up, with the MSCI Europe index up 16 per cent over one year, half of which has come since December.

Yet retail investor sentiment is guarded, perhaps in recognition of the fact that estimates have previously proved too bullish. The final quarter of 2016 saw more than £700m of net outflows from European equity funds despite equity products as a whole seeing inflows return.

With forthcoming elections in France, Germany and elsewhere having received significant attention, investors may also be wary of political risk. JPMAM’s global market strategist Alex Dryden said caution regarding both political risk and analyst overconfidence was sensible, but asserted the improving economic backdrop for Europe could not be ignored.

Mr Dryden noted that eurozone manufacturing PMIs hit their highest level since 2011 in January, and said the improvement in the growth outlook should soon filter through into bottom lines.

Ms Noculak said it was too soon to form definitive judgements. “The jury is still out,” she said. “Only a very small sample of Stoxx 600 companies have reported earnings and no clear trend has emerged in terms of ‘beats and misses’.”

But she added that the profitability gap between European and US corporates could narrow this year.

“European companies should benefit disproportionally more from a sustained improvement in the macro backdrop,” she said. “Earnings stability offered by many US corporates can be a mispriced virtue, which shifts the balance of probabilities in favour of European stocks that now offer a profit recovery potential combined with a solid valuation entry point.” 

Although M&G’s Ms Vohora warned profit margins would come under pressure for companies unable to pass on raw material price increases, JPMAM’s Mr Dryden said the recent upswing for commodities and financials stood to benefit Europe more than the US.