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18 Feb 2019

What’s next for European equities

After a troubled end to last year, and plenty of issues on the horizon, what’s next for European equities? Chanchal Samadder, Head of Equity Strategy at Lyxor ETF, shares his views.

Policy, politics and populism cloud the horizon, with large swathes of the electorate seemingly convinced that the euro project is part of the problem, not the solution. According to Lorenzo Bini Smaghi, our Chairman and a former ECB banker, some short-term caution is merited but it’s important to recognise threat and opportunity alike – and the region offers plenty of both. European assets are pricing in very little in the way of growth but we are actually cautiously optimistic about the outlook and believe sentiment could easily reverse should sentiment shift.

Confusion reigns

For now, confusion reigns and sentiment changes like the wind as recent ETF trends have demonstrated. Brexit continues to baffle, while France’s “Gilets jaunes” movement, Italy’s League and the Alternative for Germany are riding the populist wave. Globalisation and the European elite are in their sights. May’s European Parliament elections could have serious implications. Little wonder non-European investors have stayed away, despite it being one of the largest markets in the world.

Eurozone equities have been trading at around 12.0 x 12-months forward PE – 8.0% below their 20-yr median and around 23% lower than US valuations (data as of 31/01/2019). Until now though, the catalysts for change have been catatonic. Rousing them could take time, but more clarity on Brexit, a resolution to the rupture with Rome, an easing of trade tensions and signs of a recovery in growth are just a few of the factors which could spur a re-rating.

Although the rhetoric makes the risks seem skewed to the downside, economic conditions are in fact supportive. Accommodative monetary policy, budgetary policy easing, a firm labour market and concrete corporate investment should more than offset the negatives. The major factors behind the sluggish growth of late last year (disruptions in the automotive sector, the “Gilets jaunes”) were either one-offs or temporary, so they shouldn’t prove to be as much of a hindrance.

Bringing it home

More fundamentally, Bini Smaghi believes the answer is a stronger, better coordinated Europe – a Europe led by politicians capable of communicating with, and listening to, the people in the right way. Bringing non-European investors back will be a challenge but the opportunities are great if the region can reduce its dependence on exports, shift to a model of internal growth and reform more rapidly. The next wave of Europe’s growth could well come from within – which bodes well for mid-cap indices like the MDAX and CAC Mid-60 in time.

Ready for risk, open to opportunity

That said, we favour stability at this stage. Like Lorenzo, we prefer equities over bonds, but can’t ignore the short-term risks – hence our current preference for risk reducers including our unique minimum variance or quality income strategies.

At the country level, we prefer the DAX should trade tensions fade. We were less positive on France given the economic impact of the “Gilets jaunes” but those effects are now fading and it could be still be one of the main drivers of euro area growth in the quarters ahead. Recent fiscal concessions in particular could give personal consumption another boost. Switzerland, once again, may offer a bit of a haven. Periphery country balance sheets look weak and more exposed to any softening of growth, although Spain did at least prove resilient in Q4. Certainty on the Brexit outcome can’t be a bad thing, but sterling will bounce, to the detriment of exporters.

View our single country ETFs

We’ll be shifting our sector allocations into late-cycle corporates gradually, especially those capable of delivering robust earnings – which tend to be found in healthcare, oil & gas, financials and basic materials. You could consider utilities too and high dividend payers in general.  

For all that caution, it’s also important to look to the horizon and invest with the medium term in mind. We, like Lorenzo, are willing to seek out opportunity because we believe the economy will eventually pick up.

Discover our UCITS ETFs

Lyxor CAC 40 (DR)

Lyxor DAX (DR)

Lyxor Stoxx Europe 600 Healthcare

Lyxor EMU Minimum Variance

Lyxor SG European Quality Income

Source: All data, views & opinions Lyxor International Asset Management & MSCI as at 31 Jan 2019 unless otherwise stated. Past performance is not a reliable indicator of future results.

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