Three months into 2017, Europe finally seems to have broken free of the economic uncertainty that has plagued it for a decade, yet the region remains priced at multi-decade lows versus the US, on a relative valuation basis. In this article, Tim Stevenson, Portfolio Manager, discusses the impact of irrational news on investor sentiment, and whether or not the market rotation we saw in the second half of 2016 is now fully ‘priced in’.
European equity markets have hardly been a relaxing ‘buy and hold’ investment for the last few years. In 2015, global investors rushed in and bought Europe in anxious anticipation of the long-awaited recovery in European economies, spurred on by the European Central Bank’s quantitative easing program. By early 2016 it had become very clear, as we warned mid-year 2015, that those earnings would not recover by anything like as much as expected. The ‘recovery’ trade faded, European markets drifted and then underperformed sharply as political risk rose after Brexit and ahead of the busy electoral timetable in 2017.
The perverse thing about the sell-off in Europe, at least on a relative basis compared with other markets, is that from mid-2016 it was becoming clearer that Europe’s economic recovery had finally begun. In early 2017 it is actually looking very robust, with unemployment falling, investment recovering, consumer demand strong and governments no longer as financially strapped as they have been for the past few years. In many ways a vicious cycle has become a virtuous circle. What’s more, that elusive earnings recovery looks like it has finally arrived: earnings have been forecast to increase around 10% in 2017 and, three months in, that figure has actually increased somewhat, rather than slashed – as had been the case in the last few years.
Politics – the persistent problem
The one simple reason that European equity markets have failed to show more encouraging performance in the light of this better news is politics. The surprising decision by the UK to vote for Brexit created the uncertainty, and the election of Trump has continued that trend of worries. With these two major areas, the UK and US, choosing to take an alternative route, it is inevitable that the UK’s partisan local press will try to make a case that voters have not made a mistake. Undermining confidence in any news story and branding any honest opinion as ‘Project Fear’ or ‘fake news’ will ultimately grind down the most persistent optimism. What is more, all observers and interested parties are understandably nervous ahead of crucial elections in France in April and May. We believe that the far right candidate Marine le Pen will not win.
