European equities have appreciated 14.5% YTD, driving over $13bn inflows to European equity ETPs. We are positive on Eurozone equities as earnings momentum and increased economic activity combined with attractive valuations and low investor participation could provide support to the asset class. With recent elections lessening political risk in the near term, key risks to monitor include a slowdown in global reflation, compression of the yield curve and euro volatility.
After a year of $34bn outflows in 2016, European equity ETPs have gathered just over $13bn globally in 2017 on the back of a 14.5% appreciation YTD of the MSCI Europe index.1 We continue to have a positive view on Eurozone equities due to a combination of stronger growth and earnings momentum, attractive valuations, light investor positioning, and diminishing political risk.
Earnings recession is over: Eurozone equities are experiencing a strong earnings season - EPS beats are the best in 7 years.2 The recent rebound in economic activity has helped improve the profitability of cyclical names. In addition, headwinds from recent years including extremely low inflation and weak emerging markets growth, seem to be abating. Earnings revisions are accelerating at one of the fastest rates in developed markets and could drive Eurozone equities' performance.
Figure 1. Exiting an earnings recession
Eurozone earnings revision ratio vs. 12M Forward Earnings, 2012-2017 (bar and line)
Source: BlackRock, Thomson Reuters, IBES, as of May 11 2017.
Notes: The index represented is the MSCI European Economic and Monetary Union (EMU) index. Earnings revision ratio is a 3 month moving average. Forward earnings are based on IBES estimates
Leading indicators of Eurozone growth have picked up to multi-year highs: The relatively weaker euro and improving sentiment has increased economic activity. Leading indicators are at multi year highs and our BlackRock GPS suggests that this momentum is likely to continue.
Figure 2. Encouraging macro signals
OECD leading indicator and Manufacturing PMI, 2012-2017
Source: Thomson Reuters, Markit, OCED, as of May 11, 2017.
Notes: The OCED leading indicator is an amalgamation of economic and survey data that creates an indicator for future growth conditions.
Valuations and positioning remain attractive: Since the French election, cash has come off the sidelines and into Eurozone equities. Still, on a P/B basis, Eurozone equities have been trading close to historical lows vs. broad developed markets. With regards to positioning, although the improving backdrop has led to some inflows in recent weeks, investor participation in the region remains low, especially after post-Brexit outflows, which outpaced those during the euro crisis.
Figure 3. Attractive valuations and light positioning
Europe vs. world discount and quarterly ETP flow, 2012-2017
Source: BlackRock, Thomson Reuters as of May 11, 2017
Notes: Discount is the quotient of the MSCI Europe P/B divided by the MSCI World PB. Fund flow is for globally listed ETPs.
The defeat of anti-EU candidates in France and the Netherlands has greatly decreased political risk in the region. A slowdown in global reflation, flatter yield curves and sharp moves in the euro are factors to monitor going into 2017. That said, we expect the region to fare well in a better global growth environment and find current valuations to be a potential attractive entry point into Eurozone equities.
1 Source: BlackRock, Thomson Reuters, as of May 11, 2017. Notes: Performance is quote from MSCI Europe index.
2 Source: Bloomberg, UBS, as of May 2017.
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