Look to European equities beyond the China noise

Michael Barakos, Chief Investment Officer, European Equities, JP Morgan Asset Management, is forecasting annualised returns of approximately 10% for European equities over the next five years.

The Europe MSCI Index was knocked a painful 7% down just in the last week by the China worries, but Barakos says it would be a mistake for investors to shy away from the region based on short-term volatility. Instead, he sees it as an attractive entry point.

Even after approximately seven years of share price appreciation, European equities can still offer attractive returns albeit they are no longer extremely cheap on valuation. Investors need to be strapped in for a bumpy ride as the market returns to more normal levels of volatility, but Barakos argues the fundamentals to bolster rising markets remain firmly in place.

Europe’s relatively open economy leaves the region exposed to global growth trends in the generation of earnings for European corporates. Barakos notes that some European sectors derive as much as 20 to 25 percent of their revenues from their presence in the Asia Pacific region, whereas other sectors have almost exclusively domestic exposure.

As continual disappointment in emerging markets growth continues to weigh on European companies with heavy exposure to the emerging world, active managers with the ability to avoid these sectors have the opportunity to outperform.

Barakos says that one of his highest conviction positions has been an overweight preference to developed market-exposed European corporates versus an underweight to emerging market exposed companies. The differential in earnings surprises between the two types of companies last year was as much as 20%.

Europe isn’t immune from China worries, but the region’s economic outlook is still a relative bright spot. Lagging economic indicators such as unemployment have been falling steadily for nearly three years now, albeit from high levels. Barakos highlights that the positive direction of travel is the meaningful trend for investors.

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