The European stock market has long seemed like a classic value trap for many global investors who remember how Japanese equities — despite sporadic rallies — are stuck well below their record highs.
Although the FTSE Eurofirst 300 has enjoyed fitful recoveries over the past decade, it remains adrift of its pre-crisis peak. The pan-European equity benchmark has still not managed to surpass its 2000 highs, while the S&P 500 has doubled over that period.
But some analysts and investors think change may be afoot. They note that the continent is still experiencing anaemic economic growth and rising political tensions, but see reasons for optimism. And as the European Central Bank continues to keep a lid on bond yields through its latest burst of stimulus, some investors are being tempted by equities that offer a 3.6 per cent average dividend yield.
The FTSE Eurofirst is up almost one-fifth this year, nearly keeping up with the rally on Wall Street. European equity funds have now enjoyed three consecutive weeks of inflows totalling $3.4bn — the longest and strongest streak in a year and a half.
“European equities have been in the freezer sentiment-wise for a very long time,” said Kasper Elmgreen, head of equities at Paris-based Amundi, which manages €1.6tn of assets. “I don’t think we have enough data points to call it a trend reversal . . . but there are a lot of things pointing in the right direction. From my perspective European stocks are very attractive.”
Analysts point to a calming of economic headwinds as a major factor in improved sentiment towards eurozone stocks. Citi’s Economic Surprise Index, a measure of whether indicators are ahead of or below expectations, has been negative for most of 2018-19, but has recently seen a bounce into positive figures as data has started to improve.
European banks, shunned by many investors since the eurozone crisis, are a good example of the shift. Although they remain unloved in general, down close to 80 per cent from their pre-crisis peak, bank stocks across the eurozone have jumped almost a fifth since mid-August, led by near-40 per cent surges for Bank of Ireland, CaixaBank of Spain and Italy’s UniCredit.
The international backdrop has also brightened. As more than half of European companies’ sales are from overseas, markets have also responded warmly to an easing of trade tensions between the UK and the EU, and the US and China.
That brighter global picture has “eliminated at least some of the economic fears we had just a few weeks ago”, said Wayne Wicker, Washington DC-based chief investment officer at ICMA-RC, which manages about $50bn of assets.
Nonetheless, pessimism on Europe remains endemic and entrenched — with some justification. The IMF made a gloomy assessment of the continent in its latest regional economic outlook, urging governments to make plans for a “synchronised fiscal response” if growth falters further.
“Given elevated downside risks, contingency plans should be at the ready for implementation in case these risks materialise, not least because the scope for effective monetary policy action has diminished,” the IMF said in its report this month.
Strategists at Bank of America argue that European stocks are now trading about 4 per cent higher than their estimate of fair value, and probably have just another 5 per cent to gain over the next six months. “After the recent rally, much of the good news is already priced into markets,” the bank said.
European equities have also been buoyed by a shift into so-called “value stocks”, or companies trading at unusually cheap valuations, of which there are more in Europe than in the US. If the global economy takes another leg down then such companies could see their recent gains reverse even more quickly than the broader market.
Structurally, Europe also looks less attractive than many other corners of financial markets, with none of the big, fast-growing technology companies of the US or Asia’s swelling middle class. Many analysts argue that this means European stocks should continue to trade at a valuation discount to other markets.
However, some think the European equity rally still has legs — even if it is probably just a long-overdue bounce rather than a secular renaissance. Barclays’ analysts point out that many investors have relatively small positions, given the depth of the pessimism of recent years.
Even after the recent inflows, European equity funds have seen cumulative withdrawals of almost $100bn this year, and $178bn over the past 24 months. That means that if the economic backdrop and political outlook improves, many investors may get drawn back in.
Mark Denham, head of European equities at Paris-based Carmignac, which manages €35bn in assets, says he has seen more investor interest in Europe over the past two months than he has seen for several years.
“There’s a lot less uncertainty,” he said. “Europe’s been out of favour for so long that some of these headwinds may be abating.”