Barclays Equity Research says Europe is a Buy!
Barclays is joining the growing chorus saying Europe is the place to be to make money in 2015. A February 19th report from Barclays Equity Research notes that European equities are finally beginning to show signs of waking from their doldrums, and, moreover, for a number of macroeconomic reasons the future’s so bright you gotta wear shades!
Rotation to cyclicals just hitting full swing
Barclays analysts Ian Scott, Dennis Jose and Jason Hart argue that it has taken so long to see real evidence of a cyclical upturn in the economy that investors don’t believe their eyes. This means that equity investors are “playing catch-up.” They believe that cyclical sectors have finally started to outperform, and that the market is only about half way towards a “catch-up” with the economy. Importantly, they note “closing the gap fully could add another 7% to the relative performance of the cyclicals.”
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Earnings for European equities looking up
By the same token, earnings for European equities are showing signs of life. Currency movements are adding a nice tailwind, and the annual growth in reported profits for the MSCI Pan-Europe index topped 10% in January compared to January a year ago. On the same basis, the market index is up by 11%, so the multiple is flat.
At the sector level, however, the market preference for bond proxy stocks means that performance no longer really tracks profit growth. Scott et al. also note that cyclical sectors have outgrown the market, with 17% in total profits over the past year, but have seen a price appreciation of just 11%. This means multiples have contracted, and by the same token, European Financials have posted an increase in total profits of 14% and a weighted price gain of 8%.
Defensive sectors on the other hand, have seen profits decline by 2%, but the sector has seen a weighted price gain of 19%. The Barclays analysts note:”By inference, investors are already “fading” this economic recovery – de-rating the cyclicals while re-rating the defensives. This would be sensible at the end of an expansion, but seems overly cautious for one still in its infancy.”
Overweight in consumer discretionary, industrials and materials
Figure 3 shows that European cyclicals are currently trading at a forward PE discount to the defensive sectors of 16%, relative to an average discount of 11%. Scott and colleagues comment that: “At current prices, the market is factoring earnings estimate cuts amongst the cyclicals despite the evidence of earnings actually growing, and the upside surprises in the economic data. Accordingly we remain overweighted in the Consumer Discretionary, Industrials and Materials sectors.”