European stocks back in vogue

Aug 10, 2017

With political risk easing, economic growth accelerating and valuations stretched elsewhere, Europe is drawing Asian investors again. But is it a wholesale revival or a tactical shift?

Asian investors' sights have switched to equities in Europe, where political risk is fading, earnings growth is gaining ground, and valuations aren't as stretched as elsewhere.

Whether it is anything more than a tactical, as opposed to a long-term strategic, shift is another matter, with some big players advising caution.

Asian investors were more positive towards equities overall in the first three months of the year, with flows concentrated in Asian equities and outflows from Europe. But in the last three months through June the pattern has reversed, Daniel Morris, senior investment strategist in BNP Paribas Asset Management, told AsianInvestor.

“We’ve seen slight outflows from Asian equities and a swing to inflows to European equities,” he said via e-mail.

The catalysts are both political and economic. Political risks in Europe, both perceived and real, have fallen since the French election in April delivered a centrist president committed to the European Union in the face of a looming Brexit. The European economy is also seeing a better-than-expected recovery, with recent data showing eurozone unemployment at an eight-year low.

The change of heart is such that some Asian investors are piling into higher-risk, higher-beta European plays, including small-cap strategies, said Terry Pan, chief executive for Greater China, Singapore and Korea at Invesco.

Benign outlook

The improved case for European equities is supported by a benign short-term political outlook and a stronger euro.

German elections are due in September and polls suggest German chancellor Angela Merkel is poised to win a fourth term, with an eye to preserving her legacy as a defender of European integration.

The euro, meanwhile, has appreciated by more than 9% since the end of the first quarter.

“The renewed strength of the euro versus the US dollar is offering foreign investors a positive carry, paired with strong corporate balance sheets and dividend payouts,” said Hermann Spellmann, head of global equity sales into Asia Pacific at Deutsche Bank.

European equity valuations look relatively attractive too, partly because the technology sector is less weighted in European indices, unlike in the US, where stocks have been hitting multi-year highs, Spellmann told AsianInvestor via e-mail.

Goldman Sachs Asset Management is also positive on European equity markets, citing a much-awaited earnings rebound, led by cyclicals. First-quarter earnings results were the best in three years and consensus estimates have seen year-to-date upgrades, a departure from the persistent downgrades of previous years, it noted in its investment outlook report for the third quarter of 2017.

But caution advised

At BlackRock, the world's biggest investment manager, though, opinion is more tentative. Structural reforms such as greater labour market flexibility could unlock Europe’s growth potential and raise the return on equity, BlackRock said in its latest mid-year global investment outlook.

Even so, in the same report, portfolio manager Alister Hibbert noted: “The idea that people can look at European equities and make a bull case is somewhat startling. Europe is being structurally beaten in many industries.”

UBS Asset Management's enthusiasm is also more circumspect. It cautions against expecting a full-blown revival of interest in the region by Asian investors.

“Investors are pulling away from the region, at least where traditional assets like equities and bonds are concerned, but looking selectively at real asset opportunities like infrastructure,” Julie Koo, head of institutional client coverage for North Asia ex Japan at UBS AM, told AsianInvestor.

What's more, the heightened political risk in Europe hasn't entirely gone away. Although relatively subdued at present, political tensions are likely to bubble up again next year as the tortuous Brexit negotiations gather speed and elections are held in Italy in May 2018. BNP Paribas’s Morris said.

"That’s why I say political [risk] has declined, but not disappeared,” Morris said.