After such a strong rise in markets since last year’s “Whatever it takes” speech from Mario Draghi, President of the European Central Bank, many investors are asking whether European markets can make further gains. Given that wide parts of the press persist with the same old, same old ‘Europe is dead’ lament, such questions are entirely justified. There are a number of reasons why I, in fact, remain confident that patient investors will see a positive return from increasing their exposure to European equities.
Firstly, after two years of earnings declines, both “top down” and “bottom up” estimates for 2013 and 2014 are gravitating towards 6% followed by 14% growth. Both these estimates look realistic to me, even in the context of a global push to capture tax from previously hidden earnings. Hence although European markets have rerated from very low levels a year ago, earnings growth should help sustain markets from here. Viewed from a Shiller cyclically adjusted price to earnings perspective (the Shiller CAPE method), European markets are, even today, at historically low levels. From an income perspective, European equities currently have a higher yield than even Investment Grade bonds.
Secondly, there is a “weight of money” argument. While I fully accept that these can be the weakest rationale ever for buying a market, there is significant evidence that international investors are rebuilding their European allocation, precisely at the time when domestic institutional investors are also switching away from bonds, which are at present at historically high levels in portfolios as well as in terms of valuations. Recent bond market weakness may be a further incentive for investors to accelerate this move. Furthermore, if inflation is the route that Central Banks and Finance Ministries attempt to choose in preference to deflation and long term stagnation as a way to grind down the global debt burden, then equities are a far better investment. There is a lot of evidence that a sustained period of negative interest rates is a means of grinding those debt levels down over a number of years. That also explains recent reports that Central Banks have been buying equities.
Thirdly, there has started to be a concerted attempt to move the debate in Europe on from “austerity” to “growth”. That may be easier said than done, but I suspect that the recent change in rhetoric from all European leaders is highly significant. This is not Europe backing away from the underlying principle of trying to run its economy properly, but recognition of the fact that European electorates will no longer tolerate rising unemployment, especially amongst the younger population. It is more of a case of changing the “flight path” to fiscal sustainability. The fact that Germany faces elections in a few months also fuels the rationale for more economic stimulus from Europe’s strongest economy. Global economies are starting to see growth return and it looks like Europe could be in a position to join that trend as early as next year.
Related to all these points is a more widespread recognition of the leadership position of many European companies. Global investors are realising they cannot longer afford to ignore some of the world’s leading companies listed in Europe.
Recent equity market volatility is once again a typical, utterly irrational reaction to what is, in fact, good news. Clearly the world will need to wean itself off the artificial stimulus of quantitative easing – QE –, in the same way as patient in hospital will only slowly recuperate from a major illness. The fact that the QE drugs are slowly being withdrawn is the logical consequence of a more sustainable growth in years to come.
That growth will remain low, and working off the global debt burden will be a lengthy process, preventing rapid economic growth. But that does certainly not mean it is time to run away from European equities – in fact, we do believe that it is quite the opposite: continue to add on during the inevitable corrections that are bound to occur. The press may say Europe is dead, but as an investor I can declare: Long live Europe.
Opinion article by Tim Stevenson, manager of the Henderson Horizon Pan European Equity Fund
