A positive window for European Equities

European equities increased to overweight in multi-asset portfolios

We have increased our exposure to European equities, given the fact that the political risk is increasingly discounted, valuations are lower and earnings momentum is positive in Europe.

Markets had become reasonably optimistic about the global growth outlook and the implication for corporate profits and earnings following the election of Donald Trump. But his inability to push through meaningful healthcare reform has us question his ability to get fiscal spending measures and tax reform through. This, coupled with an increasing divergence between hard and soft economic data – with on-the-ground data less robust than sentiment – has led to question marks around likely economic growth. This in part led to the pullback in equity markets we have seen and bond yields coming off their near-term highs.

We have however become more favourable on European equities in recent weeks, for a number of reasons. Firstly, due to recent negative sentiment we saw heavy outflows from the asset class and European stocks became broadly cheaper on a valuation basis, relative to the likes of US equities. As the outflows began to turn, investors were provided with an attractive entry point. Also, European equities posted a strong reporting season, where results were better than already upbeat analyst expectations. The European market is also currently running with low profit margins which, when combined with a lower euro and little wage pressure, have scope to improve.

The key question is political risk. We believe that, while political risk remains a key consideration within Europe, the immediate risks have arguably been overplayed following the market-friendly Dutch election result and Le Pen becoming less of a perceived threat in France. That said, longer-term political risk remains, and that appears high in Italy, where there are elections in 2018 and, depending on the result, potential for the country to leave the euro. However, we believe that there is time for upward momentum before then.

European equities have recorded their best quarter for earnings since 2006, the Eurozone grew faster than the US in 2016 and, unlike other markets, there appears to be a copious output gap and scope for meaningful margin expansion in a reflationary environment. As we’ve said, investors have fled the continent in anticipation of political noise during the busy electoral year but we believe a European electoral calendar that passes without incident would reward European equity investors.

But we will be looking closely at key factors that could swing sentiment towards or away from global equities in the coming months. Among others, these include developments in analyst expectations for earnings growth; developments in the US taxation agenda (particularly in respect to any protectionist elements); and the development of soft versus hard data. On the latter point, we are mindful that forward-looking survey data continues to surprise on the upside – and has tracked price developments in the equity market – but realised data has been more disappointing. Sentiment is easier to influence than hard data, but can tumble quickly.

We have also been looking at commodities in recent weeks, noting that commodity markets have been forming a base at relatively low levels, at least compared to equities which remain close to recent highs. Stronger economic growth in developed and developing markets is increasing demand at a time when supply is constrained. Moreover, China matters enormously as it is the world’s largest consumer of base metals – accounting for around half of global demand – and the second largest consumer of oil. We see scope for the Chinese economy to improve (the property sector in particular) which would result in continued demand for base metals. These factors, coupled with a less unfriendly dollar, are all supportive for commodities and, while we have maintained our favourable allocation to the asset class for now, we believe all the elements are in place for a bull market to begin.

Toby Nangle – Global Co-Head of Asset Allocation, Head of Multi-Asset, EMEA – Columbia Threadneedle Investments
Maya Bhandari – Portfolio Manager, Multi-Asset – Columbia Threadneedle Investments