Time to read: 2 min
Markets around the world experienced the return of volatility during the first quarter of 2018, as central banks tightened policy and the specter of a trade war grew. Despite these pressures, the European market may offer the most opportunity.
Notwithstanding the well-publicized Brexit negotiations and a coalition stalemate in Italy following that country’s March elections, I can’t recall political risk in Europe being this muted for a long time. And, while I believe we’re in the very late innings of the US bull market, an argument could be made that Europe is in a different stock market cycle, without the same level of froth and extreme valuation.1
The first-quarter 2018 earnings outlook for the euro area projects a median growth rate of only 5% year-over-year2 and 8.4% for fiscal year 2018.3
This appears reasonably conservative when compared to the fourth quarter of 2017, when the STOXX Europe 600 Index delivered 7% sales and 16% earnings per share (EPS) growth, with 60% of companies beating sales estimates and 51% beating EPS estimates.4 With European gross domestic product this year expected to be up around 2.5%, this should underpin revenue and earnings growth projections.
After dealing with sovereign, credit, political and other crises in Europe since 2008, it is important to note that the 12-month forward EPS for the MSCI EMU Index is still 19% below its peak.5 This indicates that the eurozone’s domestic earnings base is still depressed but has good potential to climb while things remain calm in the bloc.
The European Central Bank (ECB) dropped its quantitative easing bias in March and will take its time to assess the state of the economic cycle and the risk of an escalating trade war before taking the next step of exiting QE. Assuming the rhetoric calms down, we could expect the ECB to end net bond purchases by year-end, with an eye toward raising rates by mid-2019.
I believe any tightening would be positive for the region, as higher rates tend to lead to margin expansion for banks, insurers and asset managers. I don’t believe that higher rates would pose a significant risk to equities, as bond yields would need to rise 250 basis points just to return to the long-term average of dividend yields, matching the 10-year bond yield.6 So, while I think equity valuations in Europe are close to fair value, relative to bonds they score well.
Europe is sensitive to global trade growth, but for now, it is only indirectly involved in any potential trade war, as it has secured temporary exemptions from US steel and aluminum tariffs. If that situation changes, Germany would be the most exposed, with 8.7% of all German exports going to the US.7
Looking back, 2017 posed a challenge for the Invesco International and Global Growth team as momentum was the style in favor, and we follow a bottom-up approach grounded in Earnings, Quality and Valuation (EQV) metrics. We are excited by the return of market volatility because it’s shaking out some of the momentum players and bringing some sensitivity to valuation back into play.
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1 Source: Invesco, as of March 30, 2018
2 Source: JP Morgan April Chartbook, p. 2.
3 Sources: MSCI Europe; IBES.
4 Source: JP Morgan April Chartbook, p. 17.
5 Source: IBES, as of March 31, 2018
6 Source: JP Morgan April Chartbook, p. 27.
7 Source: Deutsche Bank research, Focus Europe, March 23, 2018, p. 4.
Blog header image: jorisvo/Shutterstock.com
A basis point is one hundredth of a percentage point.
Forward earnings per share is a variant of earnings per share, and is calculated using a company’s projected earnings over the next 12 months divided by the number of outstanding shares.
The MSCI EMU Index (European Economic and Monetary Union) captures large and mid cap representation across the 10 developed markets countries in the EMU.
The STOXX® Europe 600 Index represents large, mid and small capitalization companies across 17 countries of the European region
Invesco International Growth Fund Risks:
Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.
Stocks of medium-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.
The Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the Fund.
Richard Nield, CFA
Senior Portfolio Manager
Richard Nield is a Senior Portfolio Manager with the Invesco International and Global Growth team, focusing on large and mid-cap equities in Europe, Canada, the Middle East and Africa. Mr. Nield is a co-manager of the Invesco International Growth and Invesco European Growth strategies.
Mr. Nield joined Invesco in 2000 as an equities analyst on the International and Global Growth team and was promoted to portfolio manager in 2003. He assumed his current role in 2015. Prior to joining Invesco, Mr. Nield worked as a senior analyst with Ontario Teacher’s Pension and with Ontario Municipal Employees Retirement Systems (OMERS). He began his investment management career in 1995 as an investment advisor with RBC Dominion Securities.
A native of Toronto, Canada, Mr. Nield earned a Bachelor of Commerce degree in finance and international business from McGill University in Montreal. He is a CFA charterholder.