The value investing environment in Europe is looking attractive, a Barclays report said. While asset flows, perhaps fearing an “anti-consensual” election result, have been fleeing the region, brave investors might think differently. Looking at the fundamental value numbers and avoiding the emotion of elections – a significant assumption – the European stock market appears attractive.
Value is available all over Europe
Focusing on fundamentals, Dennis Jose and his Barclays’ European Equity Strategy team consider economic data that is turning positive and valuations near the bottom end of their historical averages. This isn’t the first time Barclays has made such pronouncements. This past summer, for instance, they noted optimism. The stock rally, however, did not materialze until after the Trump election, however.
When choosing their words to describe a bull market case — where “higher profit margins” and “better pricing power” are smattered in with earnings revision ratios turning positive – there is an odd word to use in a positive context: inflation.
In a February 27 report titled “Is it time to buy Europe?” researchers not that as economic data improves, the correlation with inflation kicks in as increased demand and static supply leads to “pricing power” and higher profit margins in the region.
There is a break in the relative value chain, however.
“Indeed, across a broad spectrum of European stocks, earnings revisions ratios have turned significantly positive for the first time in five years,” the report stated, then noticing that a correlated factor, stock price, has not been following the parade. “Valuations, however, do not appear to be pricing in an earnings catch-up.”
Barclays, for its part, is forecasting 10% earnings growth in Europe as stock valuations are near multi-decade lows. In this environment, fund flows have been negative, pointing to an “anti-consensual” region. But there is one issue the consensus appears to be pricing into stocks. In fact, it is “the election elephant in the room.”
Europe could see rally if populists are held in check
The underlying concern over Brexit was the breakup of the Euro experiment. Brexit was the shot across the bow. But regional elections, perhaps starting in further cracks appearing during the upcoming Dutch election but more materially occurring with the end of the French election May 7.
“Cross-asset markets have started to respond to the upcoming elections in Europe, with France seemingly the key risk,” the report opined. A Le Pen victory could result in a more serious domino effect in Europe, potentially portending a response from the German elections September 24 that follow in the fall. “Correspondingly European stocks have underperformed as the odds of a Le Pen win have risen.”
Fears of a populist electoral result spreading throughout the region is driving negative fund flows. Looking at probability paths, it is the French election that is most concerning. The expectation is Marine Le Pen to win the first round, but fall in the second round of voting. Markets are not pricing in this positive market potential, however.
Calling the election cycle “one of the most difficult periods for European equities seen in almost half a century,” the report said value investing is coming back in vogue and value pervades the market environment in Europe.
What is likely to occur over the near term is volatility heading into uncertain elections. If Le Pen were to win the French election, it would lead Barclays to revise its generally bullish EU outcome. But what investors appear not to be factoring in is an upside surprise.
if the outcome on elections is one that doesn’t lead to a disintegration of the European Union, as per our economists’ base case, the very high level of risk premium currently priced in, may be unwarranted.
In other words, if the populists lose in France, get ready for a surprise rally.
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