The key question is can this growth continue into this year and beyond, and how is it translating into opportunities at the stock market level after a 2017 which saw the Euro Stoxx Index return 13.37% in euro terms?
According to Chris Hiorns, manager of the Amity European fund at EdenTree Investment Management, the fundamentals of the European economy remain strong, with additional room for growth.
“The European economy is at a much earlier stage in its cycle than the US and unemployment has yet to meaningfully fall in many parts of the eurozone, while wages have yet to rise,” he says.
Hartwig Kos, manager of the OYSTER Diversified GBP fund, notes that many of Europe’s headwinds have started to fade over the past year to 18 months, while monetary conditions have remained accommodative. This, he says, has clearly helped domestic consumption and investment, which is translating into strong economic growth.
“The ECB has barely started to roll down the ’emergency’ monetary policy measures, implemented in the aftermath of the sovereign debt crisis to protect the euro bloc from collapsing,” Kos says.
“Despite the strong pickup in activity, inflationary pressures in Europe have so far remained muted – but question marks about ECB policy are undoubtedly rising. Therein lies the risk for European equities.”
A key concern for Europe last year, was political risk, with several nations going to the polls, however for Hiorns, this risk is largely overblown.
“In fact, our major political concern is the spectre of instability in Germany, as its uneasy coalition settles into governing,” he says. “The general rise of populism across the region has prompted the political class to pay more attention to wages and employment, which should be broadly supportive for the broad economy and consumer-led stocks.”
Stuart Mitchell, manager of the SW Mitchell Capital European fund, notes the political backdrop in the eurozone is more stable than many in the Anglo-Saxon world perceive.
“President Macron, for example, has been able to pass his controversial labour market reforms,” Mitchell says. “These revolutionary changes include the decentralisation of collective wage bargaining.
“This will particularly benefit businesses with fewer than 50 employees – which is 95% of all French businesses – by allowing management to negotiate directly with employees, rather than through a union body. Other changes include a cap on severance pay and easier redundancy rules for French employees of international companies.”
Outlook for equities
Dean Tenerelli, manager of the T Rowe Price Continental European Equity fund, says last year investors essentially looked through most short-term political worries to focus on the stronger economic fundamentals and the recovery taking place in corporate earnings.
“On the corporate front, earnings expectations have been trending upward for the first time in six years,” he says. “However, we expect earnings growth to be slower in 2018, mainly due to the stronger euro and as companies in some sectors struggle to offset cost pressures from higher prices of raw materials.”
Kos agrees that further euro currency strength has the potential to undermine the case for European equities, particularly northern European exporters.
“The strength of the euro witnessed in 2017 had more to do with a fading away of political risks, as opposed to a change in the monetary policy,” Kos says. “This means a repricing of expectations with regards to the ECB could lead to a materially higher euro.
“A level of 1.35 against the US dollar seems utopic at this point in time, but it is worth remembering the euro was even higher not a long time ago.”
So what of European valuations? Is now a good time to start investing in Europe, or is it looking expensive?
For Mitchell, the outlook for European equities remains positive, as evidenced by the eurozone manufacturing PMI receiving a “breath-taking” 60.6 in December, which he notes is the highest level since the survey began more than 20 year ago.
“Perhaps more importantly, our company visits tell of a corporate sector recovery continuing to outpace more cautious market expectations,” Mitchell says.
“Most strikingly, European markets remain good value – trading at an unusually large 36% Shiller P/E discount to the US. Many domestically orientated companies trade at even heftier 50%+ discounts.”
Tenerelli, however, says most asset classes in Europe appear to be fully valued. But he still believes that further upside to European equities can be justified in this environment, if progress on the corporate front can be sustained over the next couple of years.
“Despite a general increase in equity valuations, we are still finding some good opportunities,” he says. “Our focus on growth-generating companies of high quality is well suited to Europe’s economic recovery.”
With monetary conditions remaining attractive, Hiorns expects construction to surge in Europe as growth begins to feed through, which he says will benefit builders and suppliers.
Rogier Quirijns, senior vice president and portfolio manager at Cohen & Steers, is similarly bullish on the prospects for construction and property in Europe.
“We see attractive real estate opportunities across Europe and nowhere is this more evident than in Berlin – which has attracted both German nationals and immigrants with its low costs of living and doing business,” he says.
“It is estimated that 20,000 new housing units are needed each year to meet new and pent-up demand in the city. Yet the market has supplied only half this amount annually in recent years, which is helping to drive rents higher. Quality office space in Berlin is also scarce, with strong job growth driving low vacancy rates and rising rents.”