European stocks have disappointed investors since 2010, lagging behind U.S. equities despite periodic bursts of optimism.
European rallies were short lived because of a series of unfortunate events, including the European debt crisis, the surge in the U.S. dollar and the U.K.’s Brexit vote. It may be hard to ignore the drumbeat of troubling headlines surrounding Brexit and upcoming European elections, but equity investors who have been avoiding Europe may want to consider investing in the region.
Global growth is improving and leading indicators suggest that positive growth trends will continue. Eurozone GDP rose an estimated 1.7% in 2016, as falling unemployment and rising wages provided a boost to household spending, while capital expenditures began to rise from depressed levels. Inflation indicators are approaching ECB targets, easing fears of deflation.
The global and regional economic backdrop contributes to rosy forecasts for corporate earnings. Consensus estimates are for European earnings growth to grow at double-digit rates in 2017, ahead of estimates for the U.S. and rest of the developed world.
The favorable outlook for earnings growth in Europe is coupled with undemanding valuations, as stock market valuations in Europe are lower than that of the U.S. The risk of a dollar “melt-up” in 2017, which would detract from European returns in U.S. dollar terms, may be overstated since measures like purchasing power parity indicate that the euro may be somewhat undervalued relative to the dollar.
Consensus expectations are for the U.S. dollar to rise relative to the euro, given an environment in which the U.S. Federal Reserve is biased to raising rates while the European Central Bank (ECB) maintains an easing bias. However, interest rate differentials are only one component of relative currency valuations, and the ECB may be more likely to taper monetary policy this year than is projected by the market.
On the Other Hand…
European markets are unloved by investors for a simple reason: geopolitics!
The Brexit vote and election of Donald Trump are fresh in the minds of investors who expected vastly different results, leading to heightened fears about the survival of the Euro. The recent widening of credit spreads between France and Germany highlights market concern about the potential breakup of the currency union.
Despite a deluge of negative headlines, elections may not upset the status quo in 2017.