Where are the opportunities in European equities?

This article is part of
Guide to investing in Europe

Where are the opportunities in European equities?

European equities are finding a place in investors’ portfolios once more.

“Sentiment on the investment case for European equities has shifted. Earlier in the year it was a consensus underweight among investors and is now a consensus overweight”, observes Guy Foster, head of research at Brewin Dolphin.

“This has not only been driven by a dramatic improvement in the political environment but a global upturn in economic activity.”

A lack of profits growth among European companies has been one of the reasons for their underperformance.

Edward Rumble, portfolio manager of the RWC Pensato European Equity fund, points out: “The relative earnings performance of European companies has significantly lagged that of the US.

"There are a multitude of reasons for this, but two significant contributors have been that while Europe grappled with austerity and deflation, the US policy response to stimulating economic growth after the crisis was more constructive and expansionary.  

“In addition, the weighting of high growth businesses such as the technology giants (Google, Apple, Facebook, Amazon) is a bigger part of the US market, while European indices have a higher weighting in banks and commodities stocks where growth has been a problem recently.”

He also suggests the risk premium ascribed by investors to European equities has been high relative to other developed markets, due to a legacy of the uncertainties over the euro, sovereign debt, systemic risks in the banking system and more unstable socio-political conditions. 

Finding financials

But the region’s financial sector does appear to be improving, having underperformed the wider market since the financial crisis (see chart).

Figure 1: Financials versus Eurostoxx

Source: Datastream, Rathbones

Financials is one of the cyclical sectors where Dylan Ball, executive vice president, portfolio manager at the Templeton Global Equity Group, sees opportunities.

He explains: “The eurozone banking industry has continued to progress with restructuring and recapitalisation efforts, and it remains an attractive option. Earnings revisions at European banks have returned to a positive trajectory, regulatory capital has been largely rebuilt, and the bulk of post-crisis re-regulation efforts is now complete. 

“Also encouraging are the swift resolutions of recent issues at regional ‘problem banks’, which indicate a newfound sense of urgency and resolve among regulators determined to ensure systemic stability.”

Liontrust’s Olly Russ, a European income fund manager, is also optimistic about the prospects for European financials.

He reasons that while investors remain wary of financials there have been very good returns to be had from the insurance sector in particular. 

“Looking forward, some banks (though not all) have entirely transformed their capital positions, with the likes of Swedbank, for example, offering even now yields of circa 6.4 per cent. If one were to perceive banks as essentially warrants on economic growth, parts of the sector look interesting.