An improving economy and stronger corporate earnings helped support European stocks last year, and the signs point to another good year in 2018.
Jeff Kravetz, regional investment director U.S. Bank Private Wealth Management in Scottsdale, Arizona, says his firm is positive on Europe because many of the same trends that propelled the region in 2017 are still in place. “There are a lot of tailwinds in Europe, which are going to continue,” he says.
Those tailwinds helped the MSCI Europe Index end 2017 up 22 percent, compared to the Standard & Poor’s 500 index, which rose 19 percent for the year.
[Read: Why U.S. Stocks Will Beat Europe and China in 2018.]
But wild cards, such as European politics, still exist. Although 2018 will have fewer elections than last year, nationalist and Euro-skeptic political parties could rattle markets, particularly if there’s an unexpected upset.
Several positive trends favor the continent. Besides improving economic growth and better corporate earnings, Kravetz says the European Central Bank will continue to pump stimulus into the European economy and keep interest rates low. “You put all those things together and that sets up a picture for a really positive 2018 for Europe,” he says.
Even though the ECB is cutting back on its bond-buying program in 2018, the central bank will keep buying bonds for at least the first half of the year, which could continue to support markets, he says.
Corporate earnings multiples also could expand in 2018, according to a research note by Sean Darby, a global strategist at Jefferies. He says countries like Ireland and Spain adopted economic reforms after the 2011 sovereign debt crisis, and since doing so, these countries’ “economies have produced stellar economic growth numbers and strong equity rallies.”
Economic reforms may continue this year, with France the next likely candidate, Darby says. French President Emmanuel Macron could bring about more labor reform in France. “He’s accomplished a few things already and is spending a little bit of his political capital,” says Brian Beitner, managing partner and portfolio manager at Boulder, Colorado-based Chautauqua International Growth Fund and Chautauqua Global Growth Fund for Baird. “He might be able to pull more off, but investors haven’t factored that in yet.”
Both Darby and Beitner see signs of a revival in European cross-border mergers and acquisitions. M&A activity there has been slow, but many European companies can afford to increase their leverage, Beitner says. While too much debt isn’t healthy, Beitner says capital spending in Europe has been running at a 30-year low.
“If the companies can take on debt, they might have the funds necessary to improve their production equipment, transport fleets and labs,” he says. “They may have the funds to acquire adjacent businesses or move into new geographies for acquisition and so forth. That could be very healthy for the European stock market generally.”
[See: The 10 Best European Stock ETFs on the Market.]
Valuations give some analysts pause. Less healthy for Europe’s markets are politics and share prices, and investors will need to consider both. As a result, Beitner sees this year’s outlook for Europe as positive but not quite as attractive as last year.
Although voters turned their backs on nationalist candidates in the Netherlands and France last year, Euro-skeptic parties can still flex their muscles, as the German nationalist party did last fall when it prevented Chancellor Angela Merkel’s party from securing a majority. Merkel now must form a collation with the nationalists.
This spring Italian voters will to go the polls, where another Euro-skeptic party is leading. The elections will definitely play a role in how markets act in the near term, says Lindsey Bell, senior investment strategist at CFRA Research in New York.
Politics, though, may be less of an issue than prices. CFRA is neutral on Europe, mostly because valuations are so high, Bell says. Although the European economic recovery is resilient, Bell is concerned about the amount of upside markets may have, given that earnings-per-share prospects are falling. The lack of earnings momentum and the likelihood that the ECB will cut back on stimulus later in the year are why the firm is neutral on Europe, she says.
European valuations are expensive, but as Beitner puts it, “everything in the world is expensive relative to itself.” Europe is highly valued relative to its long-term valuations, but it’s cheap relative to the U.S. market using various valuation metrics, he says
Beitner says the consensus view is European companies will see 9 percent earnings growth with 4 percent revenue growth. “They benefit from low labor costs, low refinancing costs and low basic material inputs; this is especially true for technology hardware,” he says. Among some of the European names he likes are energy company ENI, along with pharmaceutical companies Roche and Novo Nordisk (NYSE: NVO).
Kravetz says he’s looking at European sectors that are growing faster than the broad economy and that have pricing power as an anchor for longer-term growth. Technology is one of those sectors, he says. Thanks to stronger international growth, large and small companies are spending more on technology.
[See: 9 International ETFs That Are Off the Beaten Path.]
As the economy strengthens, another area that may improve this year after lagging in 2017 is energy, he says. “We have this global synchronized recovery taking place, so that’s really stabilizing the demand for energy.”
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European Stocks Have Tailwinds in 2018 originally appeared on usnews.com