SINGAPORE: European equities are back in favour with global investors, thanks to the European Central Bank’s large-scale bond buying stimulus. But is the bullishness warranted?
After being overshadowed by their US peers over the past several years, European equities are finally starting to shine after surging nearly 8% on a year-to-date basis as at Jan 27 (as measured by the Euro Stoxx 50 Index).
European stocks have been on the rise since the first week of January in anticipation of additional stimulus measures by the European Central Bank (ECB).
It did not disappoint — it announced a bold €1.1 trillion ($1.69 trillion) full-scale quantitative easing (QE) programme on Jan 22 to combat the rising risk of deflation in the region.
Indeed, from March until September 2016, the ECB will embark on a €60 billion per month comprehensive bond purchasing plan, which includes the buying of investment-grade European sovereign and agency debt, to stimulate growth in the flagging eurozone economies.
Of late, investment sentiment regarding European stocks has been further boosted as concerns over Greece’s possible exit from the eurozone eased.
Despite an election victory to Greece’s left-wing, anti-austerity political party Syriza on Jan 25, newly elected Prime Minister Alexis Tsipras has acknowledged that the majority of Greeks want to stay in the eurozone.
For sure, Tsipras is eager to renegotiate the terms of his country’s bailout with the Troika of the ECB, European Union (EU) and International Monetary Fund (IMF), but he has been clear that his party does not want Greece to leave the single-currency zone.
With the ECB embarking on large-scale QE and the dissipating threat of “Grexit”— a term coined by market participants in 2012 when there was widespread speculation that Greece would withdraw from the eurozone — European equities will likely maintain their upward momentum, according to investment experts.
Large-scale QE in Europe will be positive for risk assets such as equities.
The weakening of the euro will also give eurozone exporters a welcome boost, according to the experts.
Upbeat on European stocks
“We believe that [the ECB’s QE programme] is positive for asset prices in Europe and particularly for European equities.
Equity markets have performed well during QE in other countries and Europe is likely to follow,” notes Rory Bateman, head of UK and European equities at fund house Schroders, in a recent report.
The further weakening of the euro as QE in Europe commences in March will be beneficial for many European exporters.
In addition, with lower oil prices, higher consumer spending in Europe should “ensure upward pressure on corporate earnings” for the region in 2015, Bateman predicts.
“We continue to believe the economic recovery will be slow and bumpy in the eurozone, but the equity market offers decent upside given attractive valuations relative to other markets and alternative asset classes as well as a more favourable outlook for corporate earnings given the currency tailwind, lower oil price and a normalisation of the banking sector,” he adds.
Mark Haefele, global chief investment officer at UBS Wealth Management, has similarly bullish views on European equities.
Over the next six months, the combination of a weaker euro, lower oil price and record low government bond yields will guide eurozone equities higher, he wrote in a recent note to clients.
On Jan 19, UBS Wealth Management recommended its well-heeled clients to “overweight” European equities, citing the return of economic growth in the eurozone and strong earnings growth as potential positives.
Futhermore, eurozone equities are currently looking attractive in terms of relative valuations versus stocks in other regions.
Within developed market equities, European stocks, as measured by the blue chip Euro Stoxx 50 Index, are currently trading at valuations lower than those of US and Japanese stocks.
The Euro Stoxx 50 Index has a forward price-toearnings ratio (PER) of 14.4 times versus the 16.88 times of the S&P 500 Index and 19.2 times of the Nikkei 225 Index.
In addition, European stocks with an average dividend yield of 3.45% are appealing to income-seeking equity investors.
US and Japanese stocks, on the other hand, are currently offering 2% and 1.42% respectively, in terms of dividend yields.
From a macro economic perspective, the risk of deflation in Europe is not higher, according to ABN AMRO chief economist Han de Jong, who was in town recently.
“Talk of deflation in Europe is exaggerated,” says the Amsterdam-based economist.
He points out that the ECB has been on alert for any threat of deflation and is ready to act against it.
The unemployment situation in Europe is also improving.
“The eurozone is tilted towards positive events in 2015,” he says.
William Cai, vice-president and deputy investment head at local independent financial advisory firm GYC Financial Advisory, concurs, adding that macro data indicates that the eurozone economies could have bottomed out in late-2014.
“Sentiment, loan growth and data surprises in 2015 will help to drive equity returns.” Among private banks, ABN AMRO Private Banking has one of the most bullish calls on European equities this year, citing that companies in the region have the best potential for higher earnings growth on the back of ECB stimulus and a weaker euro.
The eurozone stocks recommended by the Amsterdam-headquartered private bank include French hotel- chain operator Accor SA, European car makers Fiat Chrysler Automobiles NV and Daimler AG, Belgian food retailer Delhaize Group, French commercial real estate company Unibail-Rodamco SE, French telecommunications company Orange SA, Dutch industrial equipment and machinery manufacturer TKH Group and German manufacturer of industrial robots KUKA AG.
Cautious on European bonds
Although investment experts in general are giving the thumbs up for European equities, many remain cautious on the region’s fixed-income asset class.
It is a dangerous game for investors to rush into long-dated European government bonds, whose rock-bottom yields have gone even lower in recent days after the ECB announced its QE stimulus.
“We would caution against following the ECB’s lead into high-quality government bonds at this point.
Ironically, if QE works as intended, returns for government bonds will suffer,” says Zach Pandl, portfolio manager and strategist at Threadneedle Asset Management in a recent report.
Ten-year government bonds of France and Germany are currently offering yields of just 0.57% and 0.35%, while those of peripheral nations such as such as Italy and Spain are yielding 1.47% and 1.36% respectively.
At such low yields, these bonds are giving investors extremely unattractive longterm returns, especially for non-eurozone investors, who would be subjected to currency losses from the further weakening of the euro.
“The secondary effect of QE is a weaker currency and low bond yields.
From a risk premium perspective, equities would represent a better risk/reward profile than fixed income.
As the big European multinationals derive nearly 50% of their revenues from outside of Europe, a weaker euro could help boost earnings and result in a multiple expansion,” says Cai.
Within European fixed income, perhaps the only bright spot is in the area of high yields, which are still delivering decent yields to investors.
“We do like European high yields even though they are trading lower in yields right now compared to the US and Asian high yields.
We also like the fact that monetary cycle in Europe is at a more favourable point than the US.
Whereas, the US is looking at tightening monetary policies, Europe continues to loosen monetary policies.
That type of support will be very strong for credits in general,” Todd Youngberg, global head of credit at Aviva Investors tells Personal Wealth.
Youngberg, who is gradually allocating money away from US high-yield bonds towards those in Europe, reckons that junk bonds in Europe will outperform in the near future as the region’s monetary policies from the ECB continue to be very accommodative.
Singapore-registered euro high-yield bond funds, on average, were down 4.65% in Singapore- dollar terms on a YTD basis as at Jan 23.
Over a one- and three-period, they turned in average returns of -10.02% and 24.85%, according to data of Lipper.
Singapore-registered European equity funds are faring better.
On a YTD, one-year and three-year bases, they delivered average gains of 1.73%, -3.65% and 40.41% respectively, in Singapore dollar terms.
Fund picks
For local investors who are keen to have exposure to European assets via unit trusts, they should consider European funds with a Singapore dollar hedge feature as the euro is likely to continue to depreciate against major international currencies including the Singapore dollar.
Last year, the euro lost close to 8% of its value against the local currency and so far this year, the European single currency has further weakened around 5% versus the Singapore dollar as at Jan 27.
Still, fund investors interested to add exposure to European equities could consider funds such as the Allianz RCM Europe Equity Growth and the Threadneedle Pan European Small Cap Opportunities, both of which are recommended by online fund distributor Fundsupermart for their long-term consistent returns.
These two funds offer Singapore dollar hedge share classes for investors who want currency protection from a weak euro vis-àvis the Singapore dollar.
The Allianz RCM Europe Equity Growth, managed by Thorsten Winkelmann, selects stocks of European companies that can structurally grow their earnings and cash flows over a long-term time frame and independent of the state of the economic cycle.
Winkelmann, who is “benchmark agnostic”, takes an investment horizon of at least three years on his invested stocks, focusing on best companies in Europe, such as those with high sustainable and predictable returns.
This fund, which is rated five stars by research company Morningstar and approved for investment under the CPF Ordinary Account scheme, was up 51% and 65% respectively, in Singapore dollar terms over the past three and five years as at Jan 23.
“The Allianz European Equity Growth Fund focuses on the large and mid caps, and it has a good benchmark-beating track record.
More importantly, it has a SGD hedged [share class], which benefited investors with a ‘double-bonanza’ when European equities rise while the euro falls,” says Cai of GYC Financial Advisory.
He is recommending this fund to investors who want exposure to large-cap European multinationals.
Fund investors who have existing large-cap European equities could consider haking exposure to European small caps through a diversified fund such as the Threadneedle Pan European Small Cap Opportunities, which offers risk diversification as well as additional driver of returns.
This fund, which adopts a fundamental bottom-up, stock-picking approach, has consistently delivered outperformance in terms of long-term returns over its benchmark.
Over the past three and five years, it turned in gains of 60% and 82% respectively, in Singapore dollar terms as at Jan 23.
Managed by Mark Heslop, a portfolio manager at Threadneedle Investments, this fund mainly invests in companies that are smaller than the top 300 companies in the FTSE World Europe Index.
Risk factors
Notwithstanding the improved sentiment towards European equities, especially with the support from the ECB’s newest monetary stimulus, risk factors such as economic stagnation and political discontent from Greece could still have negative impact on this regional equity asset class.
“The jury is out on whether QE will help the real economy in Europe.
The eurozone economy is very different from the US economy as it runs a current account surplus and is an exporter of capital.
QE, in our view, is not likely to have a big impact on economic fundamentals.
For this reason, it is unlikely that we will see an upturn in investment in the real economy.
Naysayers will undoubtedly question how long the positive impact of the announcement can last, given that QE will not foster the structural reform that is still needed in much of Europe,” warns Mark Burgess, chief investment officer at Threadneedle Investments in a recent report.
At the moment, Tsipras and his new anti- austerity government are keen to renegotiate the terms of Greece’s €240 billion bailout.
So far, news reports suggest that finance ministers from the 19-nation eurozone are willing to do a deal with Tsipras, so long as he rescinds his demand for a sovereign debt writedown.
In the worst case scenario, if Syriza fails to reach a compromise, breaks off ties with the Troika and refuses to pay interest on Greece’s debt; European leaders could then halt funding to Greek banks and push Athens out of the eurozone, which in turn results in runs on deposits in the small European nation, warns Azad Zangana, senior European economist and strategist at Schroders in a recent report.
“Eventually, Greece is forced to leave the EMU in order to print its own currency.
Greece enters a deep and prolonged recession, with some negative spill overs into Europe,” notes Zangana.
While this is not the most probable scenario for Greece, this is one risk that investors of European assets have to be aware of, he warns.
For sure, Greece’s membership of the European monetary union will depend on its willingness to implement the necessary structural reforms and Tsipras’s ability to reach an acceptable compromise with the Troika.
“We are almost certainly going to see a stand-off in negotiations in the near term,” Zangana foresees.
Should Syriza take “a hard-line”, the risk of Grexit will once again be elevated, causing risk aversion to the European financial markets, he says.
This article appeared in the Personal Wealth of Issue 662 (Feb 2) of The Edge Singapore.