Europe close to take off?

Europe is looking more attractive as an asset class says Darius McDermott, managing director of Chelsea Financial Services.

Europe close to take off?

Both Europe Excluding UK and European Smaller Companies were among the top five performing fund sectors in May1. With Emmanuel Macron elected in the first week of the month, investors returned to the asset class with some enthusiasm. And there are some good reasons why.

After years of disappointing economic figures and going-nowhere quantitative easing, Europe might finally be accelerating. All in all, the eurozone economy has been enjoying its strongest period of growth since the sovereign debt crisis began in 2009. Particularly reassuring is the synchronised nature of the recovery across many key data points.

For example, inflation came in at 1.9% in April, which is pretty much spot on the European Central Bank’s (ECB) target. Manufacturing is doing better than it has since 2010. And European current accounts are in surplus, which indicates a healthy trade balance in the underlying economies.

Equity valuations

What’s more, European equity valuations look quite reasonable, especially when compared to other world markets. At a basic level, they’re perhaps not ‘cheap’, but many believe that the returns on current earnings levels are depressed and have scope to bounce. On a Schiller PE level (taking average earnings over the past ten years), European prices are just under average. By contrast, the US stock market using Schiller PE is at its most expensive ever bar one occasion, just before the dotcom crash.

To sound a cautionary note, this marvellous European recovery is in its infancy and still quite dependent on support from the ECB in the form of ultra low interest rates and ongoing bond buying. Having seemingly successfully stabilised the economy, the ECB now faces the challenge of how to reduce stimulus without upsetting progress. When they meet later this week, they may start to talk about cutting back, although sudden action is not expected. Asset prices across equities, bonds and property have been inflated by quantitative easing and we could see volatility as the ECB withdraws.

And although political uncertainty has lessened now Marine Le Pen is no longer in line to be France’s next president, it’s worth remembering that the German election is yet to come and Italy seems to be in a perpetual state of potentially heading to the polls.

Appealing

In brief, I think there are enough good things going on in Europe to make it appealing, but I would be strategic with how you approach it. One option is to buy smaller companies that, in theory, could be less affected by macro volatility. This less well-researched part of the market also affords specialist fund managers the opportunity to find hidden gems among diverse countries. Two funds that I think excel in this aspect are Mirabaud Equities Europe Ex UK Small & Mid and T. Rowe Price European Smaller Companies. Depending on how ‘pure’ you want your exposure, the latter has an allocation of around 30% to the UK too.

At the other end of the scale, a fund like GAM Star Continental European Equity may be well-positioned to capture upside from the positive economic trends and improving consumer sentiment in Europe, favouring as it does large companies in consumer discretionary and staples sectors. Manager Niall Gallagher likes to hold only around 30 to 40 stocks, which he buys with a strong valuation focus and keeps for the long term – meaning he won’t get carried away in a rising market, something investors should watch for closely if Europe does indeed start to ‘take off’ once more.

1 FE Trustnet, 30/04/2017-31/05/2017

 

Please remember, no news or research item is a recommendation or advice to buy. Every Investor is not responsible for accuracy and may not share the author’s views. If you are unsure of the suitability of any investment for your circumstances please contact an adviser. All investments can fall as well as rise in value so you could get back less than you invest. 

 

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