* European small cap returns during H1 were strong at 10.3% (480bps better than Europe-large and 350bps better than Global Small), however, returns weakened in June. Our top down view suggests that this pullback provides a buying opportunity.
* Positive view on Eurozone small caps as a range of macro indicators continue to strengthen and political risk appears to be rapidly falling. Current PMIs typically coincide with c20% annualised returns and strong outperformance relative to global small and European large caps (this is in-line with the view of our Global Equity Strategy team, see A view on Style).
* We remain negative on UK small owing to the recent, sharp, weakening in macro conditions, growing political uncertainty and falling corporate spending intentions (see our recent corporate spending survey). Current macro readings tended to coincide with UK underperformance in the past.
* Earnings sentiment improving rapidly: with 12mF EPS now up 12% during past 3months driven by France (+26%), Italy (+20%) and Swiss small caps (+13%). Energy and Semiconductor earnings have moved up most but other cyclical sectors including financials are still lagging. We expect earnings momentum to further improve which supports our bullish Eurozone call.
* Valuation: European small is not cheap at c19x 12mF, however, the premium of c8% to Europe large is well below the historical c15% average whereas it also remains c20% below US small cap valuation levels. Swiss and semiconductor small caps appear cheapest whereas expectations and valuation levels for French small caps already reflect a “Macron effect”.