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Is Europe ready to take off?


French election wrangles aside, it does seem as if many European economies have the wind in their sails. The economic forecast looks as if it is improving. Many European investors are talking about a “clear blue sky” ahead and plain sailing for the best European stocks. This makes a big change from the deflationary worries that were creasing brows at the European Central Bank a year ago.

Even France has been starting to look more positive than it has done previously, with GDP picking up. As we have mentioned previously on The Armchair Trader, there are still some very undervalued French blue chips out there which have been doing well in the last few weeks – take a look at Danone, for example.

We will also see something of a tug of war between Germany and the ECB, as the German government will want to see the ECB taking its foot off the quantitative easing pedal, but some other Eurozone stakeholders, like Italy, still have a long way to go. The Italian economy is sadly the only one in the Eurozone which is not rebounding, so steer clear of Italian stocks unless you have a mind to short them.

European earnings growth is picking up, and is in positive territory, with some good numbers displayed over the last three our four quarters. Even the European banks are starting to look as if they have steered through the worst of the net interest margin crunch they endured under QE.

Some fund managers now think that the time is ripe for stockpicking in the best European stocks, rather than simply buying the Eurostoxx index. This is because correlation between share prices is close to the lows they were at in the mid-2000s when stock pickers did very well in Europe.

“Correlation has come down dramatically,” explains Guillaume Rambourg, the Paris-based co-founder of hedge fund Verrazzano Capital. “It doesn’t feel completely as good as 2007 just yet, and I think it has been more a case of sectors de-correlating…Even on a day to day basis, every morning there is going to be a cyclical day, or a switch back to quality growth. It’s been more a case of picking your sectors, then picking your stocks. Hopefully this year we will see more stock picking within sectors.”

Are the best European stocks cheap?

Another big issue is that of valuation: while European stock valuations tend to always be cheaper than in North America, a lot of money left European shores in 2016, and much of it is likely to come back once the political uncertainties have been swept out of the way. Many investors will be waiting to see the outcome of the French elections, of course. There are other dynamics involved too: QE took a lot longer to take effect in Europe than it did in the UK or the US. This is because Europeans tend to invest excess capital into savings accounts, while in the Anglo Saxon economies it will find itself back into shares through a variety of ways, thereby boosting the economy.

At the beginning of last year, Europe was everybody’s favourite market, yet 2016 turned into a bad year for investors with European shares on their books. Brexit aside, many American investors were wooed by the protectionist policies being espoused by Donald Trump. These have now become a little more muted as reality sinks in at the White House, leaving US investors to look again at the best European stocks.

Rambourg points to the Italian market as an example of what can happen when political risk is taken off the table: following the defeat of Italian prime minister Matteo Renzi in the December referendum, the market in Milan surged by more than 13%.

The elephant in the room for European stocks is that French election. A win for Emmanuel Macron would be very good news for investment into Europe. “It would give companies, we think, some visibility and it would probably create a wave of M&A, which would be enormous in Europe, both from European companies integrating with each other, but also US or Asian companies,” says Rambourg.

What is sector rotation?

Sector rotation is currently playing a big role in the way the prices of the best European stocks behave at the moment. This is where big investors like funds shift money from one sector to another: they are paying less attention to the fundamentals of a particular company, and just buying the best European stocks in one sector. This means that shares within a given sector will move up and down together. The trick right now is to find a company that will break out of this trend.

One possible additional option is to sell big stocks which have plenty of bad news surrounding them, for example using a short trade instrument like a CFD or a financial spread bet. It would then be possible to buy back into that share after you have closed your short position and take the upside. This helps you to capitalise on the knowledge you have already achieved about a particular company.

If you prefer to play the sectors game, it is also possible to use ETFs to do this. Much will depend on where you live, but among those available are First Asset Hamilton Capital European Bank ETF (FHB-TSX), ETFX Dow Jones STOXX 600 Basic Resources (BASR-LSE) and iShares FTSE/EPRA European Property Index Fund (IPRP-LSE). Numerous single country ETFs also exist, for example iShares MSCI France Index Fund (EWQ).

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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