Two years ago, European equities were inexpensive relative to their own history and relative to other asset classes. Now, according to Jonathan Stubbs, strategist at Citi Research, there is a mixed message. European equities are trading 20% above their post -972 trailing Price/Earnings (P/E) average but at post trailing P/E 1990 average. On a cyclically adjusted P/E (CAPE) basis, European stocks are cheap as they are trading at 15x, below their 20x long term average. Within Europe, Greece, Ireland, Italy, Austria, Spain, Portugal, and Belgium were inexpensive in 2012 and provided positive year to date returns in 2013. Relative to bonds and cash, European equities are inexpensive.
Jonathan Stubbs acknowledges that the risk for a correction may have risen as equities are priced higher. However, he does not think that higher prices alone are enough to turn bearish. Citi economists expect global GDP growth to improve in 2014 to 3.1% versus the 2.4% estimate for 2013. A growing global economy supported by higher consumption will likely support European firms as they increase their worldwide market share and expand to growing markets. Credit continues to be available to corporations with strong balance sheets, which allows them to invest in capital as needed, interest rates continue to be low. Citi economists also highlight that politics, Federal Reserve tapering, and emerging market risks may make the environment more challenging for European stocks.
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Source: Citi Research, DataStream
Equities underpinned by better profits, higher economic growth and potential for share buybacks
In 2013, there were 83 straight weeks of earnings downgrades. In 2014, Jonathan Stubbs and his team see better profits and fewer downgrades supported by improving economic growth and more risk taking by investors and corporations. Citi Research has 2014 year end targets for the FTSE 100 of 8000 and for the Stoxx index of 370. Cumulative earnings growth between 2013 and 2015 is forecasted at 20-25% and forward P/E at year end 2014 is estimated to come in between 13.5-14.5x.
European stocks that could see improved returns
European corporations could continue to restructure and work with their balance sheets to improve returns. For example Aviva Plc (NYSE:AV) (LON:AV), Axa SA (OTCMKTS:AXAHY) (BIT:AXA), Barclays PLC (NYSE:BCS) (LON:BARC), ING Groep NV (NYSE:ING), Linde AG (FRA:LIN) (ETR:LIN), Kering (EPA:KER), Novartis AG (NYSE:NVS) (VTX:NOVN), Renault SA (EPA:RNO), Rio Tinto plc (NYSE:RIO) and Siemens AG (NYSE:SI) (FRA:SIE) all have restructuring as a key part of their investment case. Sectors favored by Citi analysts include financials and cyclicals. Underweight sectors include food and beverage, utilities, chemicals, and oil and gas.
Source: Citi Research