Head - EMEA Investment Strategy
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Equities in Europe could extend their rise even in the face of currency headwinds
Our Eurozone equity overweight has earned the largest part of this year's return through the appreciation of the Euro. This stems from unwinding expectations of Eurozone economic underperformance and reduced policy divergence with the US. Over the last three months the Euro strength has weighed on European indices, and looking forward we expect further Euro strength which could start to prompt more negative earnings revisions than we have seen recently. However we remain overweight European equities, with the Euro strength likely to be more than offset by the following factors:
First, earnings growth is showing less dispersion by sector. So, even as exporters are hampered by the strong Euro, domestic earnings growth is expected to remain strong.
Second, European equities have significant dividend yield support. An average dividend in European equities of 3% is over three times the average corporate bond yield in the region, which is the largest discrepancy seen in recent times.
Third, there is great scope for alpha-generation through selectivity in European equities. The best areas for differentiated performance are at the theme and sector levels. We still prefer the high dividend yield and de-equitisation themes. We continue to maintain our cyclical bias over defensive sectors, with our preferred sectors being energy, financials and technology.
Fourth, the global institutional inflows into European equities are in their early stages. Ownership levels currently remain modest and we expect this to pick-up. Some of these inflows are from US dollar-based investors who could be further encouraged by the Euro strength. Other inflows are probably strategic allocations from multi-asset class investors rotating out of depressed yields in fixed income, and unlikely to be deterred by the strong Euro.