We first called for investors to consider adding exposure to European equities in September 2013 and eight months ago identified the Continent as a market where stocks could deliver decent returns in 2015. (See Destination Europe and Eurovision: Looking Forward to a Brand New Year for the Old World.)
At this juncture, we continue to expect European equities to outperform other developed markets.
European stocks usually turn in a strong performance when the global economy strengthens and the yield on German government bonds increases; the conditions are in place for Continental equities to deliver solid gains.
Our outlook calls for global gross domestic product to grow by about 3.5 percent this year, led by developed economies that have proved more resilient than many expected. On the whole, economic growth in emerging markets will slow this year, though there will be some pockets of strength.
Wage growth in developed economies has gained momentum, suggesting that inflation could be higher by year-end. On the other hand, countries that rely heavily on commodity imports have benefited from the downdraft in the prices of energy and other vital resources, helping to keep inflation in check.
The European Central Bank’s (ECB) most recent survey of bank lending suggests that demand for corporate credit, mortgages and consumer loans has started to recovery slowly. Banks in France and Italy eased their credit standards, while German lenders tightened their terms.
If credit demand continues to strengthen, the yield to maturity on bonds issued by European governments should climb to healthy levels; current returns on 10-year German sovereign bonds could return to 2 percent by the end of 2016.
In the short term, the most important drivers for the EU economy and Continental equities include the ECB’s quantitative easing, the euro’s weakness, low inflation, depressed oil prices and an easing of fiscal austerity in some nations.
The Purchasing Managers Indexes for the manufacturing sectors in Italy, Ireland and Spain—countries that undertook austerity measures to shore up their ailing balance sheets—should encourage skeptical investors. All three have climbed to levels that imply solid economic growth.
Greece’s woes have dominated the financial headlines from Europe this summer, but the Continent finds itself much better-equipped to deal with a potential “Grexit” than two or three years ago.
Whether Greece remains in the eurozone largely hinges on politics; investors should instead focus on the Continent’s cyclical recovery and the ECB’s accommodative monetary policies.