Head - EMEA Investment Strategy
July 11, 2017
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We see compelling value in European equities compared to richly rated fixed income
European equities have had a strong first half of the year, with the Stoxx 600
index rising by 6% in Euro terms. We think there is further to go, however, based
on a combination of political, fundamental, and valuation factors.
We expect 2% GDP growth in Europe this year. More importantly, this pickup is broadening across the region, as well as by the factors contributing to growth. Over the past few months, we have advocated a selective approach at the European sector and stock levels. Looking forward to the next few months we are likely to see broader annualised EPS growth of 10-15% and less stock price performance dispersion.
The EuroStoxx index PE multiple of 19 times is still at a decent discount to US equities, while the European equity yield difference with European fixed income is over 2%. The best area for differentiated performance is at the theme level, where we continue to recommend high dividend yielders and de-equitisation candidates.
Our preferred sectors are energy, financials and technology. In addition, the market enjoys strong technical underpinning, which should result in any corrections being short-lived. More specifically, institutional inflows from global equity investors looking to diversify, as well as from multi-asset investors rotating out of expensive fixed income, are in their early stages with ownership levels in European equities still only modest, with valuations also at a discount relative to US equities.
The European Central Bank (ECB) has consistently noted that its accommodative monetary policy was starting to have a positive impact on the availability of and demand for credit. More recently, this credit pickup has fed through into manufacturing and service sector indicators.
The ECB has recently shifted its emphasis, from looking through the uptick in inflation as temporary, to a more hawkish stance. Nonetheless there has been little impact on core inflation, which remains around 0.7% year-on-year, below the ECB’s 2% target. So, the ECB’s asset purchase programme is expected to be extended to mid-2018. This will probably be announced in September or October 2017. At the same time, a reduction of monthly asset purchases from €60bn is likely to be announced, given the growing supply limitations. Eurozone interest rates could then begin to rise from mid-2019.
The Global Investment Committee reduced its European high yield (HY) allocation to neutral at its June meeting. The sector has rallied by 3.9% since the beginning of the year, benefiting from inflows from yield-seeking investors, given the very low yields available in investment grade (IG). Consequently, we have seen the yield differential between HY and IG at near five-year lows. HY opportunities still exist in Europe, but investors need to be selective by region, sector, and issuer. As the ECB begins to move towards tapering in 2018 – upon which we expect more clarity at its September meeting – we may begin to see spread widening and increased outflows.
We have a slight overweight in European equities, which offer compelling value compared to richly valued bonds.