EuroView: Recovery continues and risks recede but how much is left in the tank?

In the last EuroView in January (EuroView: Rotation, earnings recovery and a view from the US), we talked about taking advantage of the inevitable market volatility during periods of political uncertainty.

At that time, investors were facing a number of European elections where the rise of peripheral parties seemed destined to wreak havoc on global markets given the potential threat to the EU project.

For those not already invested, the opportunity to “buy the dips” never arose. Centrist politicians cleaned up in France and the Netherlands while the UK’s disruptive power was significantly weakened by Theresa May’s narrow election victory.

The European equity market gained 18.0% in the year to 30 June 2017 (MSCI Europe, total return). The theme for this review is to advise our clients that, despite the recent strength, we think Europe is likely to continue to perform well against other equity markets. Equities remain attractive relative to other asset classes, in our view.

European equity market mid-year review

The MSCI Europe index delivered a total return of 6.7% in euro terms for the first half of the year. Italy has been the best performing country, up 11.3%, whilst the UK has been the laggard with a return of only 3.0% in euro terms.

The appreciation of the euro versus the US dollar in the first half of the year means that European equities have been one of the best performing global asset classes with a total return of greater than 15% in US dollars, which compares to the S&P 500 at 9.0%.

The substantial outperformance of value versus growth in Q4 last year somewhat reversed in 2017 as value underperformed by nearly 5%. Predictably in a rising market, small and mid cap companies outperformed large caps by around 3% in the first half of the year (data source: FactSet as at 30 June 2017).

We have said repeatedly over recent quarters that the “super-tanker” European economy is moving slowly in the right direction and this continues to be our view.

The first section of this review focuses on recent data and forward-looking surveys which suggest 2017 may well prove to be a decent year for growth.

Perhaps unusually, the major risks to Europe appear to be international. In section 2 we look at the main risks to the on-going European recovery and positive market outlook, namely Chinese credit contraction and possible US slowdown.

The remaining sections deal with specific themes including bond yields and inflation, the banking sector, UK & Brexit, valuations and flows.

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