A brimming political calendar will make 2017 an eventful year for Europe. While a bumpy ride seems all but certain, it could mean increased opportunity for investors, given the heavy political slate and investor skepticism.
Brexit and beyond
Brexit, of course, is on the world’s radar. On the heels of the U.K.’s 2016 referendum, Prime Minister Theresa May has pledged to trigger Article 50 of the Lisbon Treaty by March. That would begin the two-year window for the U.K. to extricate itself from the European Union (EU).
Even with the exit details not yet worked out, the significant reaction to the vote has been a key catalyst for a radical shift in terms of policy prescription and, consequently, more positive interest-rate expectations.
It is notable that the U.K.’s economy has so far defied expectations that it would quickly sink into recession. But clearly the risks appear to skew to the downside given a fair degree of uncertainty in the near term as the extrication process plays out over the next two years. That raises concerns about growth, which could weigh on valuations.
Moving beyond Brexit, Dutch elections will be held in March. Likewise in late April, France will hold its presidential election, the outcome of which will be watched closely given the potential to undermine support for the European Economic and Monetary Union (EMU). Then in late September/early October, Germany decides who its chancellor will be.
The takeaway for investors is that the market is pricing in the above-average probability of nationalist outcomes that could threaten the EMU, despite the prospect of either pro-growth candidate victories or the more typical benign European coalition governments with no clear majority.
While no one has a crystal ball for political outcomes, our Earnings, Quality and Valuation (EQV) lens provides a fundamental framework for the Invesco International and Global Growth team to seek out opportunities for our investors in times of uncertainty. Let’s take a look at Europe through that EQV lens.
Improving growth trajectory
There is scope to be more constructive on the growth outlook for Europe. Current indicators and trends support a moderate-to-improving growth trajectory on what are still-depressed levels of profitability. Germany’s strength is notable, with strong employment data and inflation recently accelerating to three-year highs.1
European earnings estimates are inflecting upward, driven by stabilizing revenue estimates. Comparatives are very easy for most bank, cyclical and commodity stocks with scope for positive surprise. The U.K. is seeing the strongest earnings upgrades, aided by strong representation of energy stocks and U.S. dollar earnings translation. In addition, weakness of the euro and pound sterling is supporting relative competitiveness of exports. Citibank’s Economic Surprise Index for Europe is at levels not seen since 2011.2
Rising investor pessimism
Despite this improving growth backdrop, continental European equity funds have suffered above-average outflows, as investor pessimism has risen sharply.3 The result is a more constructive valuation for the MSCI Europe Index: 14.5x price-to-earnings (P/E) ratio for low double-digit earnings growth, versus the S&P 500 Index trading a little above 17x P/E for high single-digit earnings growth.4
In summary, concerns about economic growth and political outcomes generally weigh on European valuations, which historically tend to favor the upside versus the downside for long-term investors. As always, we believe our long-term, bottom-up stock-picking approach can reward investors in uncertain environments.