Barclays is bullish on European equities. A recent report from the firm argues cyclically oriented stocks are ready to run, and suggests 400 as a price target for Pan-European STOXX600 for 2015.
Ian Scott and team at Barclays in their European Equity Strategy report dated December 8, 2014 titled: “2015 Outlook: Reaching the rotation” anticipate continental European earnings would grow by 15% in 2015.
2014- A year of disappointment for European equities
The Barclays analysts note that so far this year, European equities have delivered a 7.5% total return in local currencies, marking 2014 as a disappointing year. They point out that the market has failed to live up to their bullish expectations, and once again has lagged the U.S.
However, they anticipate European equities will be a better investment in 2015, as they believe “sentiment” towards European equities appears to have swung decisively. They note a year ago European equities were enjoying some outsized inflows – especially from overseas – while since July investors have turned sellers. As set forth in the following graph, at least since 2009, sentiment measured in this way has provided a useful contrarian “call” on the performance of European stocks:
They also note that monetary policy and the prospect that the ECB will announce a program of “public” QE early in 2015 is supportive of equities. Moreover, there is now more than 200 bps between the interest expenses paid by European companies as reflected in their last published accounts and the current BAA corporate yield. The analysts point out that the gap is now wider than it was in 2004/2005. Of note, for companies with levered balance sheets, refinancing costly debt facilities at lower rates could provide a substantial boost to cash flows:
Scott and team note that at the current relative price/book ratios, investors appear to be taking a view that the profitability of European stocks relative to U.S. stocks will remain depressed over the long run. As the analysts anticipate improvement in profitability in 2015, they believe this will be a catalyst for the market to re-rate relative to the U.S.
Sector and regional allocation
Scott et al anticipate cyclical sectors will outperform in 2015, while sovereign QE from the ECB would support domestically-oriented cyclicals.
The following graph captures the correlation of the relative performance of the 24 MSCI Level 2 sectors with changes in the Euro Area economic sentiment index. The analysts would prefer to focus exposures in Banks, Transport, Diversified Financials, Materials, Cap Goods, Construction, Autos and Insurance.
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They recommend the following sectors weightings versus the MSCI European benchmark. Barclays is overweight on Industrials, Materials, Technology and Financials and are underweight on Consumer Staples and Healthcare.
Turning the focus towards regional allocation, Barclays remains overweighted peripheral European stocks through 2015. Of note, thanks to high level of real yield on Spanish bonds vs German bonds, Spanish equities are at a 20% discount to the MSCI Europe benchmark on a price/book basis. However, the Barclays analysts anticipate that sovereign QE should reduce the gap in real yields, which will reduce this valuation discount and lead the Spanish market to outperform.
The following table captures Barclays recommended European portfolio:
The following table summarizes Barclays European index target for 2015: