IT’S BEEN a while since Europe excited global equity investors. For most of the past few decades, there’s always been something a little more exciting – the US, emerging economies, private markets.
But as the world emerges from the COVID pandemic, there’s a whiff of excitement about European equities. And that provides opportunity.
“In my world – continental Europe – earnings forecasts still look very much too low,” says Paul Wild, senior fund manager at JOHCM Global & International Equities. With second quarter earnings season only a fortnight away, Wild expects continued surprises vis-à-vis a year earlier.
“While it’s clear that peak earnings momentum has past, it is still going to remain positive. We could see earnings growth approaching 50 per cent for 2021. Also with European GDP in 2022 likely higher than this year, the earnings outlook stays strong”
Banks and financial companies, like most major markets, are a large part of European equities. But they are behaving atypically at the moment, and that could provide an opportunity.
“The story of European financials is not really yield curve driven at the moment. It’s more about the effects of coming out of the crisis, and that’s about normalising provisions,” Wild says.
Banks increased provisions for bad debts at the beginning of the pandemic, but as the macro environment turned out to be better than forecast, provisioning requirements have fallen. The banks are over-capitalised, Wild says, and that means big dividend payouts later in the year.
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The other factor for European (and global) banks is inflation.
“The commentary from the Fed a few weeks ago is far and away the key event of recent times,” Wild says. “The market was very much positioned … for the Fed to let things run hot. But the Fed’s dot plot effectively called for two rate hikes in 2023 – they were much more hawkish than what the market was positioned for. The yield curve flattened.”
The question is: has the market interpreted the Fed correctly?
“It’s very difficult for anyone to make a real call on inflation with absolute convictions at the moment given the transitory effects, given past mistakes it seems unlikely the Fed will be too pre-emptive” Wild says.
“Overall global valuations are pretty high at the moment, but Europe looks quite reasonable versus the MSCI World. Whilst bonds are still priced for the moon,” he says.
“If you buy a Government bond, in many cases you are committing yourself to a negative real return. So, then you look at equities and the cash dividend potential, particularly in Europe. It looks like growth in the region can stay sustainably strong until the back of 2023,” Wild says.
“For so long Europe has just been lacking in any positive theme, and that’s now changed as it emerges stronger from the pandemic.”
Paul Wild is senior fund manager with J O Hambro Capital Management, a London-based active investment manager which is part of Pendal Group.
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