Date: 12-08-2015
Source: The Wall Street Journal
For once, the problems for European stock investors aren’t coming from Europe
European shares were never going to be able to maintain the fierce rally that kicked off the year. While the Stoxx Europe 600 is still up an impressive 15% year-to-date, it has essentially moved sideways since April. Now, despite better corporate earnings and Europe’s ongoing recovery, investors face some inconvenient headwinds.
For once, the obstacles to better performance are external, not homegrown. The eurozone recovery, supported by European Central Bank bond purchases, a weaker euro and lower oil prices, is progressing steadily. Greece appears no longer to be a threat to the eurozone’s economic performance, and has made surprising progress on its third bailout deal, allowing it to fade into the background for many investors.
Vitally, European corporate earnings have finally emerged from a long torpor, helping to support the expansion in multiples to 15.8 times the next 12 months’ earnings. This year should mark the first since 2007 that eurozone earnings outgrow those in the U.S., up 15% versus flatlining, says asset manager NN Investment Partners.
As of Aug. 6, 56% of Stoxx Europe 600 companies that had reported second-quarter earnings had beaten expectations, a good showing for Europe versus an average since 2011 of 48%, according to ThomsonReuters. Some have high expectations indeed: HSBC forecasts European earnings excluding U.K. companies to rise 25% this year.
But while Europe’s companies are arguably in the sweet spot, the global backdrop is not as encouraging. Once the boost from a weaker euro has washed through, it will be growth that matters.
A year ago, the International Monetary Fund forecast 2015 global growth at 4%; now it has 3.3% pencilled in, with emerging markets growth slowing. China is clearly in the spotlight. Its unexpected move to devalue the yuan Tuesday was described as a “one-time” adjustment, but opens up the risk of further weakness, which could be a fresh disinflationary force in a world already troubled by low inflation. It also raises questions about the Chinese authorities’ response to now wide-ranging economic problems. Meanwhile, the U.S. Federal Reserve may be gearing up to raise interest rates, which is likely to cause risk aversion at least in the short term.
Greater uncertainty may also yet hold back company executives from actions that might reward shareholders. Far from leveraging up to take advantage of ultra-low interest rates, European companies have largely remained conservative. Aggregate net debt versus earnings before interest, taxes, depreciation and amortization may fall to 1.8 times for European investment-grade companies in 2015 from 2.1 in 2014, its lowest post-crisis reading, Bank of America Merrill Lynch analysts forecast.
Europe’s relative and new-found status as a safer home for investors’ cash is likely to persist. That should make European stocks relatively resilient; buying on dips has proved a good strategy. But without a new impetus—such as a renewed fall in the euro, a pickup in the global growth outlook, or fresh shareholder-friendly activity—hopes of further big gains for European stocks look misplaced for now.
