The Outlook Is Bright for European Stocks in 2017
Companies with a U.S. footprint, including British American Tobacco and Inditex, could have a strong 2017 if local currencies stay weak.
The outlook for European equities is surprisingly bright going into 2017, given the political clouds gathering around the euro zone and the broader European Union.
With at least three general elections in the offing amid surging support for anti-establishment parties and the United Kingdom’s slowly unfolding Brexit drama, investors might be expected to head for the hills. They shouldn’t.
The Stoxx Europe 600 index is widely forecast to fare better next year than its 1% loss so far in 2016. More telling is its performance over the past three months, when it has risen 4.7%, fueled by improving economic indicators. While most economists currently expect the euro zone’s gross domestic product to loiter around the 1.4% annualized growth rate it notched in the third quarter, investors have been buoyed recently by better-than-expected data, including encouraging purchasing managers’ activity and retail sales figures. Consensus forecasts put the Stoxx index at around 381 at the end of 2017, a gain of 5.8% from the current level.
Jie Zhang, an associate director at asset manager Signia Wealth, says political uncertainty will boost volatility and offer bargain-hunting opportunities for active investors. “Given current valuation levels, once political uncertainty is removed, European equities have lots to offer on the upside,” says Zhang. The forward price/earnings ratio for the Standard & Poor’s 500 is 19.1 versus 16.4 for the Stoxx.
Indeed, Europe’s political backdrop may not be as daunting as some fear. Italy replaced Prime Minister Matteo Renzi with a moderate who could stave off new elections that might otherwise boost the influence of the anti-EU Five Star Movement; the Netherlands’ potential election of an anti-immigration candidate in March is likely to result in a coalition of centrist parties; France’s anti-EU National Front leader Marine Le Pen may make it to the second round of the country’s presidential election in May but isn’t expected to win; and despite challenges, Chancellor Angela Merkel’s party and its affiliates continue to outpoll other German parties, making it likely they would be involved in any coalition government after September elections.
Gerrit Smit, who manages the U.K.-based Stonehage Fleming Global Best Ideas Equity fund (ticker: STGBIEB.Ireland), says the global economic outlook is positive, with expectations that U.S. President-elect Donald J. Trump will boost infrastructure spending and with the continued strong growth in some Asian economies—all of which should be supportive of European equities.
In particular, Smit says the weakness of the euro and the British pound against the dollar, combined with market volatility caused by geopolitical uncertainty, presents investors with stock-picking opportunities. He recommends investing in European companies that benefit from having a euro or sterling cost base but generate income from stronger currencies, especially the U.S. dollar. On Thursday, the euro touched $1.043, its lowest level against the dollar since 2003, after the Federal Reserve said it was raising interest rates.
Smit’s choices include Britain’s Wolseley (WOS.UK), which, despite its London listing, has a strong U.S. presence as a supplier and distributor of building materials. It would profit from more infrastructure spending. He also likes FTSE-listed Diageo (DEO), the world’s largest spirits maker and a major U.S. exporter.
Another beneficiary, says Smit, is British American Tobacc o (BTI), which will benefit if its $47 billion offer for the 58% of Reynolds American (RAI) it doesn’t already own goes through. That would give it a solid U.S. footprint.
IN THE EURO ZONE, Smit recommends the Spanish parent of fast-fashion store Zara, Industria de Diseno Textil, or Inditex (ITX.Spain), which he says has a competitive edge due to its rapid response to new trends and flexible delivery options, whether in-store or online. “They’re extremely competitive, and you can just imagine the success they could have now as a global business with quite a low euro cost base,” he says. “They may have really good results in 2017.”
Rob Lutts, chief investment officer at U.S.-based Cabot Wealth Management, says international investors might never have been as wary of European stocks as they are now. As a result, valuations are especially attractive in some sectors.
He favors the financial sector and recently invested in the iShares MSCI Europe Financials exchange-traded fund (EUFN). “When I buy an ETF, I take the top 10 holdings and really look at the individual companies and try to understand what their risks are,” says Lutts. “I know that in any bank it’s hard to understand all of the risks, but they’ve been working for quite some time to clean up their balance sheets, and get a little stronger, and they warrant a higher valuation than they have today. You could get the European banks to go up 15% or 20% and not have any improvement in the fundamentals, just an improvement in psychology.”
Sentiment will improve—for banks and lots of other sectors—if Europe manages to get through a fraught political year without too many surprises.