Europe is making a comeback in investors’ minds, says iShares’ Cohen
Stephen Cohen, head of Investment Strategy, iShares EMEA, comments on the outlook for the region and why Europe is showing signs of turnaround in investor allocation, with German and UK equities his favourites across the continent.
Europe’s cyclical year-end
Europe is making a comeback in investors’ minds. A cyclical uptick in June has persisted, even if not a significant growth turnaround, and after years of Europe being associated with market tail risk, performance and fund flows are turning around. The recovery however is not about a major shift in growth, but a case of a sentiment reversal and reallocation into a previously unloved region, and for many, a long-term underweight. While we remain cautious in the long-term on structural challenges, particularly in the eurozone, short term momentum is strong – inflows into total European equity funds have broken multi-year records in recent weeks, with investors also starting to broaden into high-beta segments, such as Italian equities as well as broad European small and mid-caps.
Stabilising economic data and growing hopes of a continued easing bias from the ECB are contributing to this sentiment lift, especially after the recent rate cut. Eurozone contagion risks are significantly lower than this time last year, thanks to Mr. Draghi. This is evident in the performance of peripheral sovereign bonds. For instance, while Italian government bonds sold off during the recent Berlusconi saga, Spanish government bonds stayed relatively steady.
Risks move further down the tail, with UK and German recovery portraying a stronger and more sustainable recovery
The past quarter saw European equities outperform US and emerging markets as Europe tail risk dropped. While certain emerging economies this year find themselves in a funding crisis exacerbated by deteriorating current deficits, European countries, in contrast, have generally moved into current account surplus.
Valuation-wise, in spite of some recent revaluation, European equities are still attractive, especially compared to their US counterpart. The shift of tail risk from Italy and peripheral Europe to US politics could further Europe outperformance, especially high beta.
While Europe still faces long-term growth challenges, the recovery momentum looks most sustainable in the UK and Germany. Both markets also have high international exposure, diversifying their sources of revenue.