European equities – Buy before the squeeze

Global investors have refrained from investing in Europe for some time now. Over the past three years, a gap of almost 30% has opened up between the European market and the US.

This factor is attributable to the positive investor-appeal of the US over the past few years, exacerbated by the malfunctioning European project.

The political landscape is highly complex in the region, even incomprehensible for non-European observers. Although global investors fear political or even economic paralysis in Europe, we believe that the elections in 2017 and the Brexit provide an opportunity to increase momentum towards greater integration, less centrifugal interference and ultimately improved political functioning.

We are therefore convinced that once the elections are over, global investors will reinvest massively in the region, which we believe now appears historically compelling.

Our investment case is based on three keywords: Sentiment – Fundamentals – Squeeze

Sentiment

European services and industry sector PMI indices, on a regional scale and nationally in France and Germany, are bullish for European equities. Newsflow is extremely positive, including job creations, faster growth, and even resurgent inflation towards normal levels, which was unthinkable two years ago.

The US ISM indicator has diverged sharply from the economic growth trend and should mechanically converge downwards towards GDP, whereas European indicators remain much more coherent with economic reality.

Current investor sentiment regarding the Trump administration harbours risk of disappointment if negotiations with Congress delay the implementation of the electoral promises.

Fundamentals

Sources for corporate earnings growth currently differ, as a function of whether companies operate in Europe or in the US. The rise in EPS in the US has stemmed mainly from cost-cutting and share buyback programmes, whereas earning momentum in Europe has resulted chiefly from dynamic sales growth.

Furthermore, cycle-adjusted PE ratios imply that Europe is now particularly cheap compared to the US.

In terms of valuation, the current spread between the US and Europe is at its widest level in several decades, in favour of Europe.
Europe has never been such good value compared to the US.

Squeeze

Global investors are currently underinvested in Europe. Furthermore, European trading volumes are significantly lower than in the past. The probable massive return of investors ahead of the French elections, combined with thin traded volumes, is likely to create a squeeze effect and therefore considerably amplify upside potential among European equities.

Summary

Several factors have combined to convince us that it would be wise to reinvest in European equities and to do so immediately. Economic and confidence indicators are extremely positive, while political incertitude will soon be alleviated, providing Europe with fresh momentum, as global capital is reallocated into a thinner market.

Geoffroy Goenen – Head of European Equities – Candriam Investors Group