European equities dipped slightly following the Fed’s decision not to taper, ending what had been a strong run so far last month. But the underlying trends haven’t changed, and Europe looks poised to really start growing in 2014. Uncertainty is down in Europe, and assuming no surprises (like the results of the asset quality reviews coming early next year), cyclical Euro stocks are a good place to be, argues Barclay’s analyst Joao Toniato.

Equity markets were off to a strong start in September

“Equity markets were off to a strong start in September, but after the FED surprised investors by not tapering they drifted somewhat lower as concerns about US debt ceiling negotiations and government shutdown took hold,” writes Toniato. “Despite these developments, equities reported strong performance… European equities, and in particular Italy and Spain, should outperform.”

European equities

Toniato thinks that earnings growth for the Stoxx 600 could be as high as 4 percent this year and could reach 12 percent next year, both significantly higher than consensus even last quarter. “Our forecasts are driven by our view that European profit margins should be at a cyclical trough,” he writes. “European profit margins are low because we have had a severe contraction in deficits when investment was poor.” The contraction in deficits, driven by deleveraging, may not be over, but as investors pull their money out of emerging markets and bring them back to the U.S. and Europe the investment landscape is becoming more favorable.

Eurozone is facing a long-term monetary crisis

The best way to take advantage of the changing situation is to look for value stocks in cyclical sectors whose prices have been held down by political uncertainty. While some people still think the Eurozone is facing a long-term monetary crisis, the European Central Bank is providing the financial sector with everything it needs to get through the AQRs, and talk of periphery countries exiting the Eurozone has all but stopped.

Long-standing bullish stance on European equities

So in the short to medium term, there should be steady growth, and companies that have trailed the market slightly (but with sound underlying financials, of course) should outperform the rest of the market. “With economic sentiment improving we reiterate our long-standing bullish stance on European equities and in particularly on cyclical sectors,” writes Toniato.

value v growth performance