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Long-Awaited European Stock Rally May Be Here

Posted by hkarner - 27. Oktober 2016

Date: 26-10-2016
Source: The Wall Street Journal

European stocks haven’t lived up to expectations this year. That might make them more attractive.

against-the-flowFor European stocks, 2016 has been a testing year. The consensus was that Europe would do well; instead, it has been a consistent laggard. That may yet be an attraction.

European stocks started 2016 badly and have moved sideways since March. The Stoxx Europe 600, excluding U.K. shares, is still down 4.5% this year and some 15% off its 2015 highs, even as U.S. indexes have hit new records in 2016.

But the gloom may be lifting. On Monday, Germany’s DAX index closed in positive territory for the year for only the second time in 2016. Hopes of global growth are rising into the end of the year; in Europe sentiment data is suggesting a strong start to the fourth quarter. Tuesday brought a forecast-beating reading on the closely watched Ifo German business sentiment index.

The lag versus other indexes creates some allure. The Stoxx Europe 600 excluding the U.K trades on 14.7 times the next 12 months’ earnings, according to FactSet, versus 16.6 times for the S&P 500. But the more compelling case is versus bonds, which are particularly expensive in Europe, and where the prospects for future returns are poor indeed. The bond rally has stalled, and inflation looks to have bottomed out. A weaker euro and higher bond yields could increase the attraction of European stocks.

mind-the-gapSet against that are plenty of risks. European politics has been a regular source of worry for investors, and the calendar is still full of red-letter days. December brings the Italian constitutional referendum, while elections loom next year in France and Germany. Still, political risk in the eurozone has tended to be overstated. U.K. stocks could face more volatility over Brexit concerns.

European banks clearly are a big concern. But a good deal of bad news is priced in; on a price-to-book basis the sector is close to its crisis lows, Citigroup notes. The situation might simply have to stop getting worse for sentiment to turn. A shift in monetary policy that allows for steeper yield curves and doesn’t delve further into negative interest rates would be a step in the right direction.

There is also some potential technical support. One problem the market faced at the start of the year was the weight of expectations: Many investors already were overweight in European stocks. But among developed markets, the region has suffered the biggest outflows in 2016, J.P. Morgan notes. The experience of emerging markets this year shows that assets can swiftly shift from unloved to in demand. And if bond yields remain low at the start of next year, then investors will need to take more risk to hit return targets.

The case for European stocks isn’t that they offer an obvious outright opportunity—few assets do in today’s markets. But in a world of relative value, being a laggard means investors should take a second look.

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