Europe best placed for cyclical upswing

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Europe best placed for cyclical upswing

For the beginning of the last three or four years, investors have been perennially overweight Europe, only to be disappointed as the year goes on. With expectations low and investors mostly neutral or underweight, however, could it be time for European equities to shine?

At first glance, allocating between equity regions looks like a tough job this year. The US has possibly the strongest macro picture but American equities look fully valued, having risen dramatically following Donald Trump's election.

At the other end of the spectrum, emerging markets appear cheap but face an uncertain outlook under a new US regime. Investors have been burnt by Japan, are nervous around China and don't see much beyond a currency devaluation for the UK.

This leaves just Europe ex UK, which investors distrust because of political risk and the rise of populism.

Strong eurozone economy

Yet the outlook for eurozone economy is actually very strong. 2016 closed with the eurozone displaying some positive economic momentum, with the manufacturing PMI accelerating to its strongest reading for the year.

Private consumption is contributing significantly to growth, with unemployment having reached a new post-2009 low late last year.

At the same time, the global backdrop is also becoming more supportive. Europe, Japan and emerging markets are traditionally the three 'higher beta' regions which do well out of an accelerating global economy.

Europe chart 

Europe appears to be the one best placed to take advantage of a cyclical upswing for now, with a friendlier global growth backdrop feeding into a positive domestic story.

Admittedly, European equities have posed something of a conundrum in recent years; while the economy and company sales have already recovered to post-crisis highs, earnings have remained lacklustre and stuck near their cyclical lows.

Yet, with growth and inflation picking up, earnings could now begin to come through more strongly. Even some of the most bearish investors are now revising up their expectations for earnings growth, as well as their year-end targets for the Euro Stoxx 600.

Much of the current pessimism around Europe comes from political risks, with elections either due or likely in every major country except Spain. Stronger growth, however, could tilt the balance away from populists and towards the status quo.

A victory for Marine le Pen may be the biggest risk, but the binary choice in the final round of the French elections is likely to work against her. Indeed, a centrist win in France could be a good catalyst for European equity outperformance.

Bill McQuaker is a portfolio manager of the Fidelity Multi Asset Open Range.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.