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MRB's Chart of the Week: why Euro equity euphoria will lead to tears

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MRB's Chart of the Week: why Euro equity euphoria will lead to tears

MRB has recommended an underweight position for aggregate euro area stocks within a global equity portfolio, which has paid off in recent years – at least until the past few months.

The recent rebound has been driven by attractive relative valuations, deeply oversold conditions (excessive pessimism) and hopes that policy initiatives (such as the outright monetary transactions programme) will set the stage for an economic turnaround. These hopes are premature, and we expect relative stock performance to fade in the months ahead.

By contrast with MRB’s overall cautiousness towards euro area equities, we have recommended an overweight stance on German stocks in recent years, given the market’s superior earnings performance. We are maintaining this stance, despite regional economic woes, because Germany provides a leveraged play on an improvement in the global economy. The key to a sustained rally in the overall euro area market will be for the German economy to revive, helping to lift the weak periphery economies out of recession.

 

Moreover, an upturn in regional credit demand will be critical to lift the important financial sector, a necessary ingredient to sustaining a broad stock market rally. Structural reforms and much lower real interest rates in the periphery countries are also key outcomes needed to support a durable, multi-year uptrend in relative stock prices; so far, these condition have not been met.

In sum, keep a close eye on leading economic indicators for the German economy and relative earnings expectations to gauge when to upgrade euro area equities within a global equity portfolio.

Until then, investors should remain focused on the healthy companies and economies in Europe (Germany and Sweden), as well as the various investment opportunities overseas. 

Peter Perkins is a partner at global investment analyst the Macro Research Board

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