Europe's Turn To Shine

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Includes: ADRU, DBEU, DBEZ, EEA, EPV, EURL, EZU, FEEU, FEP, FEU, FEUZ, FEZ, FIEU, HEDJ, HEGE, HEZU, HFEZ, HFXE, HGEU, IEUR, IEV, SBEU, UPV, VGK
by: The Financialist

EuropeanUnionforShine

The first few days of 2016 were not kind to European and American equities: They each fell 8 percent in the first nine trading days of the year, the worst-ever start to a new year. But the year's inauspicious beginning isn't necessarily a sign of things to come - at least, not for European stocks. From the potential for further easing by the European Central Bank to a resilient regional economy, a host of factors play into an increasingly promising forecast for European equities. Even though major European indices have recovered some of their 2016 losses, Credit Suisse believes these rebounds have legs.

News of monetary easing tends to bolster share prices, and on January 21, the ECB hinted of future easing and European stocks rose. Following its meeting, the ECB announced that it would keep its benchmark rate (0.05 percent) and overnight deposit rate (-0.3 percent) unchanged. (The announcement came a month after the central bank lowered its deposit rate from -0.2. percent to the current -0.3 percent.) Of equal importance to financial markets was the dovish message central bank president Mario Draghi delivered after the meeting.

With Europe still far short of its inflation target, the bank will "review and possibly reconsider" its monetary policy at its March meeting. Credit Suisse believes that the March meeting will bring, at a minimum, a 10 basis-point cut in the deposit rate as well as changes to the ECB's asset purchase program. Those changes could include increasing the size of the bank's asset purchases or broadening the program to include corporate bonds. Credit Suisse believes that European small-cap stocks, in particular, should outperform following the ECB's moves because small-cap stocks, as relatively risky assets, tend to be especially sensitive to QE.

Further easing by the ECB would also put downward pressure on the euro, which has already declined sharply against the dollar since its 52-week high of $1.17 in August - as of January 28, it was trading at $1.09. A weaker euro would provide further support to European equities because of the prominent role the export sector plays in the region's economy. Exports account for 26 percent of the Eurozone's GDP, higher than the U.S. (13 percent), Japan (19 percent), and even China (24 percent).

Also supporting European equities: A recovery that continues even in the face of global turmoil. Retail sales growth in Europe is at a 16-year high and employment is at a four-year high. The composite Purchasing Managers' Index (PMI) declined to 53.5 in January from 54.3 in December, but the "slight decrease" was expected given January's economic uncertainty, according to a recent note by Peter Foley, a European economics analyst in Credit Suisse's Global Markets division. "There doesn't appear to be much sign of a meaningful slowdown, and we expect the steady domestically driven recovery to continue," he said.

Key to the euro area's resilience is the health of small and medium-sized enterprises (SMEs), which represent 90 percent of all businesses in the European Union. In the last two to three years, declining interest rates on short-term loans have benefited such businesses throughout Europe, especially in Portugal and Spain, where rates have dropped more than a percentage point. Loan origination in Europe is also up, increasing about 2 percent over last year.

Put it all together, and the Credit Suisse Europe Chief Investment Office team believes the consensus forecast of 8 percent EPS growth for the year ahead is too low. Using a model based on Eurozone GDP, Credit Suisse forecasts that EPS will grow 15 percent.

The significance of macroeconomic indicators and corporate earnings notwithstanding, there's one potential driver of Euro area equity performance that's not domestic: U.S. investors. Over the past eight years, Eurozone equities have underperformed U.S. equities by 50 percent, but the Europe CIO team thinks a rebalancing may be in the offing. Though U.S. equities aren't expected to head into bear market territory, a rally doesn't appear likely either, thanks in part to December's Fed rate hike. The beginnings of interest rate cycles are associated with "listless" markets, and a Credit Suisse analysis of tactical indicators suggests the U.S. market is likely to remain range-bound for much of this year. Which means that U.S. investors might become buyers of Europe before too long.

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