European stocks climb their own wall of worry

“America is not a country, it is a world,” remarked Oscar Wilde in an interview with the Cleveland Leader about his time in the US. Since Donald Trump’s victory in the presidential election, Wall Street’s record run has outpaced global equities, not least in Europe.

While US investors have become accustomed to regular equity market grand slams — days when the four main US equity benchmarks enter record territory together — the pan-regional Euro Stoxx 600 last set an all-time peak in April 2015, as did Germany’s Xetra Dax 30.

If investors are satisfied that the Trump trade is not a world unto itself, there should be opportunities to exploit in Europe, particularly given the more appealing valuations for companies seen being well placed to benefit from the US becoming a locomotive for the global economy.

“European stocks certainly look cheaper than their US counterparts,” says Paul Markham, who manages £4bn of global equities at Newton Investment Management. “European exporters are well-placed to benefit from a rise in growth and inflation in the US.”

While eurozone equities have rallied sharply in the wake of the US election with the Euro Stoxx index up nearly 7 per cent, featuring a 14 per cent advance by the Stoxx Banks index, headwinds beckon in the shape of eurozone politics.

For a continent that has been rattled this year by Brexit and the resignation of Italy’s Matteo Renzi, after the country rejected constitutional reform, the prospect of elections due in France on April 23 and in Holland on March 15 loom large over markets.

Investors are also mindful that after being one of the most hotly-tipped asset classes to perform well at the start of 2016, European stocks have failed to live up to their billing and thus remain cheap for a good reason.

A key ingredient is earnings growth, and analysts say the return of rising profits will help drive money back into European shares. Also set to play a key role is the extent of further weakness in the euro as it boosts dollar-based revenues for European exporters.

Karen Olney, a strategist at UBS, points out that Europe’s slow return to profit growth since the financial crisis leaves it needing just a small improvement in performance to reap a bigger comparative rise in earnings, leaving the region looking all the more attractive.

“We think 2017 is the year that EU profits could turn. If investors continue the move into inflation-exposed sectors, then Europe is well suited . . . with 40 per cent of Europe’s dividend yield coming from financials and from energy stocks, the areas best placed to benefit from a return to inflation.”

Fund flow data suggest there are eye-catching conditions ready for any such trend to take hold.

According to figures compiled by UBS, the gap between cumulative inflows into US and European exchange traded funds tracking equities has opened up into an eye-catching $145bn after the election. It was $10bn in 2015. The size of the current gap implies that a move back into the region from international investors looks overdue.

To get international capital back into Europe, you need profit growth,” says Ms Olney. “Anything Mr Trump does that creates the kind of inflation that will trickle down into the rest of the world will help.”

If that happens, Europe’s financial and energy sectors should be among the main beneficiaries. With the first global deal to limit crude oil supply since 2015, oil stocks are already making up ground.

But it may take time to turn round sentiment, and JPMorgan Asset Management argues: ‘’European assets face poor earnings growth and political risks in 2017.’’

Newton’s Mr Markham is also cautious, and for reasons which have nothing to do with the White House: “Continental European stocks tend to be cheaper on a pure price/earnings ratio basis, because management is less dynamic. Governments tend to be less comfortable around markets and balance sheet returns are often lower. We would never expect European stocks to trade at valuation parity for this reason.”

Nonetheless, the front-loaded nature of the political calendar for 2017 could provide an opportunity in itself.

Says UBS’s Ms Olney: “The risk premium will decline further as the year goes on. Investors can take positions early on in the year, and then reap the benefits.”

Additional reporting by Keith Fray