Investors see tempered upside in European stocks

Morgan Stanley institutional investor base favors European equities over the next 12 months. This was also the case last year. However, the majority of institutional investors see reduced return potential estimating gains of up to 10% for the MSCI Europe. Over the last 12 months ending on June 19, the MSCI Europe has risen 20.7% relative to the S&P 500’s gain of 21%.

Institutional Investors Europe

June 2014 reply

Source: Morgan Stanley Research

Institutional Investors Europe

June 2013 reply

Source: Morgan Stanley Research

Jason Gilbert, founder and Managing Director at RGA Investment Advisors LLC, encourages investors to look beyond their borders to find investment opportunities. He believes European stocks remain inexpensive relative to other equity markets such as the U.S.

Institutional Investors Europe preffered equity

June 2014 reply

Institutional Investors Europe

June 2013 reply

Source: Morgan Stanley Research

Global growth supports European company revenues

Morgan Stanley analysts led by Graham Secker noted that institutional investors expect tepid euro area GDP growth with about 80% of respondents estimating growth for 2015 to be at or below 1.5%.

Institutional Investors Europe GDP growth

Source: Morgan Stanley Research

Investors, however, do not see deflation as a likely event. They believe that the European Central Bank (ECB) will take appropriate measures to manage deflation risk, including keeping rates low, boosting intermediate term bank lending and quantitative easing. The latter will involve buying assets such as bonds from financial institutions to encourage them to lend. Benoît Coeuré, an ECB executive board member, acknowledged today that quantitative easing is a possibility but highlighted that it is not needed currently.

Institutional Investors Europe Deflation

Source: Morgan Stanley Research

Institutional Investors Europe QE

Source: Morgan Stanley Research

European stocks could gain despite slow economic growth in the local economy as companies drive revenues from overseas. The euro’s strength has provided downward pressure on companies’ foreign sales and profits on the first quarter of this year. Morgan Stanley analysts estimate that earnings per share (EPS) for large cap European companies are poised to grow 8% in 2014 and 12% in 2015. EPS improvement will come from both sales and margin growth.

Companies in peripheral Europe may be more affected by slow domestic growth as they tend to be more cyclical. Although Spanish and Italian banks may benefit from increased credit access, such improvement may already be reflected in current prices. Institutional investors polled by Morgan Stanley (NYSE:MS) are more cautious on peripheral stocks, with 37% keeping an underweight relative to the MSCI Europe.

Institutional Investors Europe Current positioning

Source: Morgan Stanley Research

Rising activism may support stocks

More activist shareholders are working with European firms as a result of more hedge funds seeking investments. According to the June 2014 issue of the Activist Insight, 10% of activist actions are directed at European companies versus 62% directed at U.S. companies. Change of ownership structures, including mergers, is a common trigger for activist actions. Some activist investors, including Alex Roepers from Atlantic Investment Management believe in a more constructive approach. Roepers sees opportunities in Europe and has been engaged in the region for about 10 years. He believes that working jointly with management to enhance value and keeping disagreements behind the scenes allows for more flexibility and privacy, especially if he wants to exit the position.