• Earnings recovery should support further stockmarket gains in 2016.
• Careful stockpicking will be needed as correlations within markets are likely to unwind.
• Eurozone economic recovery to continue, driven by the improving credit cycle and domestic demand.

Scope for profit margins to improve

Corporate profit margins within the eurozone particularly remain at depressed levels relative to the US.

This gap has been significant since the global financial crisis and a narrowing of the disparity would support European shares.

At the same time, valuations are compelling versus historical levels and most other equity markets.

Stock selection crucial as correlations unwind

Whilst we are constructive on European equities overall it is probable that there will be significant differences in terms of thematic and sector leadership.

Correlations within equities (i.e. where shares are moving in the same direction) have increased markedly since the summer when the Chinese devalued the yuan and intervened in the stockmarket.

A possible US rate increase and concerns about a hard landing for the Chinese economy triggered a market sell-off across asset classes which reflected a ‘risk-off’ period of uncertainty.

We believe the opportunities within equities for 2016 will require careful stock selection as correlations unravel, leading to more differentiation between stocks and greater opportunity to generate alpha (i.e. to add value in relation to risk taken, relative to the benchmark).

In both the bond and equity markets, ‘quality, safe’ assets have seen a period of strong outperformance to the extent that the defensives (less economically sensitive stocks) versus cyclicals are back to level seen through the eurozone crisis.

Corporate bond yield spreads have significantly widened versus government debt despite the global deflationary pressures.

These moves indicate nervousness across markets that the global economy may be entering a more difficult period.

We would agree that the global economic outlook is more uncertain but the extreme moves we have seen in ‘growth versus value’ have opened up valuation anomalies as indicated by the chart on price/book value below.

Eurozone recovery has momentum

From an economic perspective we are confident that the eurozone recovery will continue through 2016 despite the emerging market turmoil witnessed during the late summer.

The export market is clearly suffering but overall the data suggest to us that the eurozone economy has momentum in its recovery phase driven by domestic demand, credit expansion and consumption growth.

It’s worth noting that services and construction make up 75% of German GDP and these areas of the economy are performing well.

The same can be said for other large eurozone member countries.

The eurozone can also count on the ongoing support offered by the European Central Bank’s (ECB) quantitative easing (QE) programme.

Recent surveys from businesses and consumers show that QE is having a positive effect on credit growth which is crucial if economic expansion is to be maintained.

Additionally, ongoing QE will help keep the euro under pressure, especially if the US Federal Reserve does decide to raise interest rates.

There could be more easing on the way in the eurozone: Mario Draghi recently warned that global forces may have a negative impact on GDP growth and suggested that further measures could be announced imminently.

In summary, we see a positive outlook which is likely to be enhanced if the ECB takes further policy action.