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Last updated: August 15, 2013 3:45 pm
The eurozone’s emergence from recession in the second quarter of this year has refocused investor attention on the prospects for the region’s equities, particularly given their strong showing compared with Wall Street since the end of June. Can they maintain this momentum?
John Higgins at Capital Economics is sceptical that eurozone equities will continue to outperform those in the US, despite their much more attractive valuations.
“Indeed, we forecast prices to end this year lower than they are now, before grinding higher,” he says.
“The total return from eurozone stocks was just 2 per cent in the first half of 2013, compared with 14 per cent from US equities. But since the end of June, the total return from eurozone equities has been about twice that from the US.
“However, the revival in the relative fortunes of the eurozone seemingly owes much to a belief that the region’s economy is firmly on the mend. The 0.3 per cent expansion last quarter masked continuing contractions in Spain and Italy, where growth is sorely needed.
“As such, we would not be surprised if the debt crisis flared up again at some point in the next few years.”
Alan Higgins, chief investment officer UK at Coutts, says the region’s recovery has also been reflected in second-quarter earnings reports, with more than half of European companies beating forecasts.
“Most striking was the high number of companies highlighting stabilising business conditions, not just in northern Europe but also in the south,” he says. “But for the European market to make further progress we need this to be reflected in earnings forecasts.
“By our analysis, purchasing managers’ indices (PMIs) tend to have a high correlation to return on equity (ROE), with a nine-month lead. As PMIs have been rising for the past nine months it is likely that ROEs – and consequently earnings – will start to rise.
“If this earnings recovery comes through – and we think it will – then European equity markets have an even better chance to make up for their underperformance relative to US stocks.”
Andrew Wilkinson, chief economic strategist at Miller Tabak in New York, agrees that the big question for investors is whether the return to expansion is likely to alter eurozone earnings expectations.
“S&P 500 company earnings are expected to grow by 22.7 per cent, from $110 to $135 per share, by 2015,” he says. “That values the market at 15.36-times this year’s expected earnings. The Eurostoxx 600 index, by contrast, trades at a multiple of 13.94-times with EPS growth of 31.7 per cent.
“For the French CAC 40 index, earnings growth of 24 per cent over the next two years values the market at 12.99-times 2014 earnings.
“If the French and German economies continue to rebound they will inevitably deliver employment growth across the eurozone periphery, while adding to a pick-up in global trade. That certainly remains a big ‘if’. But both events would be positive for US corporate earnings.”
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