European equities have surged since European Central Bank (ECB) president Mario Draghi (pictured) declared he would ‘do whatever it takes’ to drive a eurozone recovery, so almost two years on is the party over or is there more to aim for?
Investors certainly retain confidence in the continent, despite the dark macro clouds of tensions in Ukraine and deflation.
The latest BofA Merrill Lynch fund manager survey shows that institutional investors now believe the eurozone crisis has passed with the continent now the most favoured regional overweight after Japan across those surveyed.
This optimism is shared in the retail market, with data from the Investment Management Association revealing that European equity funds were the third best-selling by region in March, after clocking up net inflows of £141 million.
Those who got in early have been rewarded. In the near two years that have passed since Draghi’s pledge in July 2012, the MSCI Europe index is up 40%, powering ahead of the FTSE All Share and S&P 500, which rose by 33% and 30%, respectively, over the same period.
Despite disappointing eurozone GDP expansion in the first quarter, with growth of 0.2% half the 0.4% consensus expectation, investors point to pockets of growth which are throwing up opportunities. Several of these centre around consumption. Many investors have switched their focus from the European multi-nationals, on the back of concerns about slowing emerging market economies, towards domestic-focused companies.
Alice Gaskell, manager of the BlackRock Continental European Income fund, said: ‘We have seen early signs of a recovery in the European consumer sector, with improving business confidence and falling unemployment, which has been positive for European equities.’
Ben Kumar, an investment manager at Seven Investment Management, is playing a similar theme, saying that while the rerating of European equities has seen some of the eurozone ‘crisis discount’ relative to US and UK stocks eroded, the process still has further to run.
‘For this reasoning we like the look of the small and mid-cap sectors in Europe – they have moved in line with their US and UK cousins since mid-2012, but are a long way off their pre-crisis highs,’ he said.
Standard Life Investments’ head of global strategy Andrew Milligan warned policy risk remains at the macro level, noting: ‘Fiscal programmes and structural reforms remain constraints, while the ECB has not managed to improve credit availability in many sectors.’
Inflation also remains stubbornly beneath 1%, considered the ‘danger zone’ and well below the ECB’s target of 2%. Views are mixed on the scale of the threat this poses.
Capital Economics’ Roger Bootle last week warned that ‘Europe is turning Japanese’, sliding into a deflationary spiral that will result in sovereign defaults. But his long-standing prediction has yet to play out and Kumar is more sanguine.
‘While we do not feel this is likely to become entrenched as a serious economic threat, it would increase pressure on the ECB to take some kind of action,’ he said. ‘So far, the ECB has maintained its profile and its reputation through the threat of action, rather than [acting].’
As for the Ukraine crisis, although any flare-ups will cause spikes in volatility, Pimco’s Francesc Balcells, hopes Russian self-interest will ultimately curb any ambitions it has in Eastern Europe.
‘Russian corporates are among the most active in international debt markets, and Russia has tried hard, and successfully, to open up its local currency debt markets,’ he said. ‘A confrontation in the West would erode many of these achievements, driving more foreign investors away. However, when it comes to geopolitical ambitions, rational thinking can take a back seat, which leaves the range of potential outcomes in Ukraine wide open.’