Research from ETF provider Source currently favours European equities over those from the US.
Andras Vig, director at Source Research, said: “Total return from European equities has been near zero over the year-to-date, as negative sentiment has offset decent dividend income and growth.
“While there are pockets of risk in Europe – mostly in banks – we believe the prevailing negative sentiment is not justified. Although some of the uncertainty will remain, there is enough growth to support equities in the region. In particular, we have also softened our negative stance on European oil & gas and have upgraded it to neutral.
“While we remain more positive on equities in Europe than the US, we still expect steady economic growth in both regions, although the UK might experience a mild recession,” he said.
"There are a number of factors that we consider are supportive to the market’s recovery.”
Don’t lose faith yet
Italian bank insolvency, Brexit negotiations, and populist politics across Europe have prompted many investors to shed their European equity positions in recent months, according to Jaisal Pastakia, investment director at Heartwood Investment Management.
While the company has also reduced some of its European equity allocation of late, it continues to hold a modest overweight exposure.
“In fact, there are a number of factors that we consider are supportive to the market’s recovery,” said Pastakia.
Eurozone resilience – Eurozone financial markets have shown more resilience than compared with more turbulent periods in 2011 and 2012. Headline events, such as the Spanish elections, had limited market impact and euro sovereign peripheral debt spreads (i.e. the difference in yield relative to the risk-free rate) have remained relatively stable. Domestic demand continues to be a big driver of growth in the Eurozone and it is encouraging that broader economic confidence indicators have held up well post the UK referendum.
Domestic demand is being supported by credit cycle improvements – European Central Bank (ECB) stimulus measures continue to have a positive impact on bank lending, despite concerns earlier in the year that negative interest rates could hurt banks’ profitability and lead to retrenchment in lending. The ECB’s second quarter bank lending survey showed credit conditions had eased amid improving demand for loans among households and non-financial corporates. It is interesting to note that ECB policy measures are increasingly directed at boosting credit as opposed to weakening the currency.
European bank balance sheets are stronger than they were in 2011/2012 – The ECB stress tests show that banks in most countries have come a long way in boosting Tier 1 capital ratios and have stronger buffers in place to withstand a significant market or systematic impact. The Italian banks are the obvious outlier, given concerns around the solvency of smaller banks and how to address the issue of private bail-ins, since Italian bank bonds are predominately owned by retail investors who would not be in a position to absorb large capital losses. However, progress is being made at the regional level and the European banking system is much healthier than in 2008, or indeed, in 2011/12 at the height of the euro sovereign crisis.
Valuations are cheaper and the reduction of investor positions in European equities means that it is a less owned market. This provides the basis for stronger demand in the future as the fundamental outlook improves.
Less focus on fiscal austerity – Governments have been able to maintain a looser fiscal stance this year than compared with previous years. We have also seen the ECB and European Commission show a more pragmatic response towards countries’ fiscal policies. The Spanish and Portuguese governments avoided fines in July for not cutting their budget deficits sufficiently, and have been given more time to resolve these financing issues.
