Russell Investments has switched its equity weighting in the European region away from the UK towards countries that are members of the single currency union, driven by a more positive outlook coupled with cheaper valuations.
The manager’s strategists cite “double digit earnings per share growth, low oil prices, accommodative monetary policy, and cheap valuations relative to the US”.
Its forecast is for GDP growth of between 1.5%-2.5% through 2015 across the region.
In contrast, it predicts single digit EPS growth from US companies, coupled with rising wages and inflation that could lead to reaction from the US Federal Reserve, which in turn causes a spike in market volatility and bond yields.
However, the positive outlook for Europe does not stretch to the UK.
Wouter Sturkenboom, senior investment strategist, said: “Not only do UK listed companies source a lot of their profit from abroad, the equity market is heavily skewed toward the materials and energy sectors. The UK market suffers from the double whammy of a strong pound and commodity price declines. The uptick in euro-zone growth is partly compensating for this, especially in financials, but as the fall of UK earnings expectations for 2015 into deeply negative territory shows, this is not enough. In recognition of this disappointment, we are moving to a small underweight position in UK equities.”
“We see a potential for higher volatility through 2015, driven by both price momentum and the economic cycle. If wage gains jump, then equities, bonds and credit could all post negative returns.”
Looking to Russell Investments’ “cycle, value, sentiment” process:
• Business Cycle: Europe stands out
While the U.S. and Japan have a moderate cycle score, Europe is currently very positive. US profits are growing at a moderate pace, supported by robust economic growth. Japanese profits are also on the upswing as a result of lower energy prices and the likelihood of additional stimulus from the BoJ. Corporate profits in Europe, which have been sluggish over the past four years, are now very promising due to improving economic indicators and the ECB’s QE program. The Emerging Markets (EM) have a negative cycle score due to rising dollar, falling commodity prices and regional political instability.
• Valuation: US equities are very pricy
Both Japanese and European equities are moderately expensive after strong runs in both markets. The US is still the most expensive equity market, with a price-to-book value at 2.9 times and the cyclically adjusted price-to-earnings ratio of over 22 times. Emerging Markets continue to look cheap.
• Sentiment: Momentum strengthens in Japan and Europe
Many of the contrarian signals – such as investor-sentiment – remain in overbought territory, pointing to a potential modest pullback in equity markets. However, momentum, which strengthened in Japan and Europe, continues to act as a positive driver in most equity markets. Within the US, momentum weakened, but a separate indicator – the declining level of margin debt at the New York Stock Exchange – suggests that the US is not yet over-exuberant.