At Morgan Stanley’s Global Investment Conference last week, nearly half the investors chose Europe as their most preferred equity region over the next 12 months with over three-quarters saying they were bullish on the region’s growth prospects.
Krupa Patel and team at Morgan Stanley in their June 15, 2015 research report titled: “European Equity Strategy” note that Europe’s macro momentum is picking up.
Europe’s PMIs remain solid
The Morgan Stanley analysts point out that euro area economic data have been holding up better than anticipated. They note Europe’s Economic Surprise Index has now turned positive for the first time in 5 months:
Patel et al. forecast a 2.2% GDP growth for the euro area in 2016. The analysts point out that the macro news flow in recent weeks including eurozone PMIs, money supply growth, support their forecast.
As can be deduced from the following graph, euro area nominal GDP growth is now above 10-year bond yields for the first time since 2007. The MS analysts point out that such an environment is typically a bullish signal for equities:
Patel and colleagues also point out that Europe recently returned to consensus earnings upgrades for the first time since March 2011 after 210 consecutive weeks of downgrades. The analysts’ top-down forecast for European earnings growth is 12% for this year, as they believe companies will benefit from improving macro conditions, FX tailwinds and low borrowing costs.
Six reasons to buy European equities
Patel et al. argue the buy case for European equities remains intact for six reasons, viz.: (a) Europe’s economic surprise index has turned positive for the first time in 5 months, (b) the earnings upgrade cycle is still on track as financial conditions continue to ease, (c) investor interest in Europe is returning as mutual fund flows have started rising again, (d) corporate activity continues to pick up, (e) normalized valuations are still low Vs history, and (f) their Combined Market Timing Indicator is close to a ‘buy signal’.
Elaborating further on pick up in corporate activity, they point out that Europe has witnessed a significant pickup in M&A deal volumes in the 18 months. Moreover, buyback volumes are still muted in Europe.
However, striking a cautionary note, the Morgan Stanley analysts point out that the top-down case for Europe vs global regions is now a little less compelling. They point out that the gap between Europe vs US dividend yield and credit yield has now closed and the relative 12-month forward P/E is now trading above its historical average:
They argue that the recent stabilization in the currency, coupled with continued growth momentum, should encourage more bottom-up stock picking. The following table captures the analysts’ list of 33 OW/EW rated European stocks that they believe are leading franchises globally and trade at favorable valuations relative to their US/global peers: