Date: 30-09-2018
Source: The Wall Street Journal
While U.S. and Japanese shares raced ahead, Europe’s shares were left behind in third quarter
European stocks have been left behind by a rally that has taken the U.S. market to record highs in the third quarter.
Few analysts see the region catching up soon, unless there is clarity on the political and trade concerns that pushed investors to sell.
Investors have withdrawn money from European equity funds in 28 of the past 29 weeks, driving the share of Europe in global portfolios to its lowest since January 2015, when the European Central Bank announced its massive bond-purchase program, according to data from fund tracker EPFR and the Institute of International Finance.
That has largely reversed the tide of cash that poured into the region in early 2017, when an election in France elevated investors’ preferred candidate to power. In contrast, funds in the U.S., Japan and even some emerging-market equities have drawn inflows this year.
The Stoxx Europe 600 index rose less than 1% in the third quarter, compared with a 7.2% gain for the S&P 500 and 8.1% for Japan’s Nikkei Stock Average. The European index is now trading below where it was one year ago, compared with an 8.2% gain in a broad index of world stocks.
“U.S. client interest in Europe is very low right now—almost as low as it gets,” said Richard Turnill, BlackRock’s global chief investment strategist.
As the U.S. economy continues its robust run, the gap between 10-year German and U.S. government bond yields has reached its widest since the euro was launched in 1999, according to data from Tradeweb and Thomson Reuters.
The downbeat sentiment comes even as Europe’s earnings expectations for the year have remained stable, the euro and British pound have stopped climbing, and the region’s economy has shown signs of stabilizing after a tricky start.
“Our view on Europe is predominantly politically driven,” said Candice Bangsund, portfolio manager at Fiera Capital, which currently holds a smaller-than-usual allocation to European stocks.
The future trading relationship between the U.K., one of the region’s largest economies, and the rest of the continent remains uncertain as Brexit negotiations drag on. Italy’s new government, meanwhile, has significantly widened its budget-deficit target, raising questions about the country’s debt sustainability and relationship with Brussels.
The U.K. and Italy’s benchmark stock indexes have both seen double-digit percentage falls in their price-to-earnings ratios this year amid the uncertainty.
European companies are also more exposed than those in the U.S. to emerging markets, and the developing world has been hit by a rising dollar, expensive oil and concerns about trade protectionism.
Roughly 19% of revenues from companies listed in the Stoxx Europe 600 come from emerging markets, according to FactSet. That compares with 14% for the S&P 500, an index of large-cap U.S. stocks.
Roland Kaloyan, head of European equity strategy at Société Générale, said the correlations between European stocks and emerging markets recently reached levels last seen in 2010.
But trade protectionism is by far the biggest risk to Europe’s outlook, analysts say.
Europe’s auto sector has been hit particularly hard by worries about tariffs, trading down about 23% from its peak in January.
“Europe is more exposed to protectionism because it has a more open economy and has closer ties to China,” said Silvia Dall’Angelo, senior economist at Hermes Investment Management.
Uncertainty about future trade relations has already hit eurozone exports. In manufacturing, export orders failed to grow for the first time in five years.
All this means there will be bargains in Europe, should more clarity come on the political front, some investors say.
European stocks now trade at 13.9 times future expected earnings, compared with 15 at the start of the year.
European companies are seeing revenue upgrades for the first time in a year, according to strategists at UBS . “A lot of investors are looking at valuations and looking for a reason to come back” to Europe, said Mr. Kaloyan.
“If we got some sort of clarity on Italy or Brexit, we could see a rebound.”
Much will also depend on whether investors continue to favor so-called growth stocks such as technology companies, which make up a small portion of European indexes. Tech stocks in the S&P 500 are up roughly 19% this year and now make up 21% of that index. Tech makes up just 5% of the Stoxx Europe 600. Unless value stocks—those that are trading for the lowest prices relative to their earnings or underlying net worth—start to outperform, it will be difficult for Europe to pull ahead, fund managers say.
NEW YORK – Not too long ago, the conventional wisdom held that “Japanification” could never happen in Western economies. Leading US economists argued that if the combined threat of weak growth, disinflation, and perpetually low interest rates ever materialized, policymakers would have the tools to deal with it. They had no problem lecturing the Japanese about the need for bold measures to pull their country out of a decades-old rut. Japanification was regarded as the avoidable consequence of poor policymaking, not as an inevitability.