Goldman: Expect European Equities To Bounce If French Elections Don’t Surprise

“If elections in the Netherlands and France do not result in tail risk outcomes, this should remove a major source of investor fears; we would, therefore, expect European equities to enjoy a bounce and a period of relative outperformance” writes Peter Oppenheimer, Goldman Sachs’ Chief Global Equity Strategist in the bank’s Top of Mind Global Macro Research magazine March issue.

French Elections
By Gauthier Bouchet (Own work) [CC BY-SA 3.0], via Wikimedia Commons
Oppenheimer’s piece, titled “equities and elections” considers the state of the European equity markets vs. the US. While European economic indicators have been improving, European stocks are still lagging far behind their US peers. For example, the European composite PMI for February hit a 70 month high of 56 but year-to-date the Stoxx 600, and Eurostoxx 50 indexes are up about only 3.3% compared to 5.5% for the S&P 500.

Goldman: Expect European Equities To Bounce If French Elections Don’t Surprise

Even though the US has its own political problems, Europe’s politics are much more unpredictable, which is why Oppenheimer argues, European equities could be set for a bounce if the threats this risk poses never materialize.

Goldman’s Global Equity Strategist goes on to list six reasons why European equities could see election relief months.

First off, European equity markets are geared to global growth and typically outperform at times when global growth accelerates. Goldman’s analysts estimate that a 1% rise in global GDP-weighted by the sales destinations of companies would boost European profits by 11%, all else equal.

Second, weakening domestic currencies are a tailwind to Europe’s foreign exposed companies.

Third, for the first time since 2010 earnings revisions in Europe have turned positive. While this is largely a function of commodity sectors, it is nonetheless a big turnaround from recent years.

Fourth, European equities are starting to look unusually cheap relative to the US. The 12-month forward PE of the Stoxx 600 is 14.9x—more or less in line with recent years—compared to 18.1x for the S&P 500, which has increased since the Fed rate hike in 2015. The median stock in the S&P 500 now trades in the 99th percentile of historical ranges over the past four decades. The P/B for the S&P 500 is 3.1 times, while for the Stoxx 600 it is 1.8 times.

french elections
French Elections

french elections

Fifth, European banks are starting to perform better thanks to improving macro fundamentals. Typically, when banks outperform in the European market, the European market outperforms the US.

And lastly:

“Political concerns have already pushed investors away from Europe; 2016 was a year of large selling of European equities by both European and US investors. All told, if political risk moderates in line with current polling, European equity fundamentals are likely to reassert themselves in a more positive way.”

Although, while there could be good things ahead for European equities if political risk dissipates, Oppenheimer ends his article with a word of warning:

“We caution that an unexpected win by Marine Le Pen in France would raise serious redenomination risks and, as a consequence, potential systemic risk. Thus, it would be dangerous to view the substantial rally in US equities post the unexpected election of Donald Trump as a precedent; in our view, a sharp and potentially prolonged sell-off in European equities would very likely ensue.”