European Equities equipped for earnings recovery, says AXA IM’s Mark Hargraves

After two years of flat earnings, Mark Hargraves, manager of the AXA Framlington European fund, anticipates that 2014 will be the year that European investors finally start to experience an earnings recovery.

With systemic risks dramatically reduced in Europe, investors are starting to focus on underlying fundamentals for European equities. With signs of an improving economic backdrop, combined with many sectors such as financials undertaking self-help measures to improve profitability, the backdrop is set for a return to earnings growth after a challenging two years.

While Europe has performed well over the last twelve months, with some of the ‘easy pickings’ already been made, the reality remains that European equities continue to trade at the lower end of relative valuation ranges compared to many other developed equity markets.

Given the weak economic backdrop, European earnings have lagged those in the US over this cycle. This is unusual as typically both profit cycles have moved fairly closely historically. As such, the earnings catch up potential in Europe remains large, in contrast to the US where profits are at an all-time high.

We do not downplay the remaining structural challenges facing Europe, as further fiscal and debt rebalancing is required, with the result that this recovery is likely to be weaker than historic ones. However, many of the structural imbalances, such as Southern Europe’s competitive position have been largely resolved providing the basis for a more sustainable improvement in economic performance.

A combination of attractive relative valuations, greater earnings recovery potential and the restart of positive fund flows from international investors provide a very attractive backdrop for the asset class currently.

Europe currently offers an attractive combination of exposure to domestic recovery, whilst be able to maintain exposure to the broader global economy. Holdings such as BNP Paribas, Mediaset and ING provide investors with good quality domestic recovery potential, while companies such as Richemont and Publicis can provide investors with exposure to longer term global secular growth trends.

The tough economic backdrop in Southern Europe has provided a challenging backdrop over recent years, but as conditions stabilize we are seeing some interesting opportunities to pick up some interesting recovery opportunities. Over the last twelve months additions such as Mediaset and Valeo have provided some very attractive returns.

I believe many European banks continue to look interesting at present, as a combination of falling systemic risks, stronger capital bases and a return to dividends provides an interesting opportunity for investors. The AXA Framlington European fund has been overweight banks for over 18 months, reflecting the improvements that we’ve seen in the sector.

We focus on banks that combine strong franchises, attractive valuations, some growth potential and the ability to return to cash dividends. Examples include BNP Paribas, KBC and ING.

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