Europe: A great environment for stock-pickers

In its current form, the European Union is like a bicycle. It needs to keep moving forward or it will fall over. Although it could be a bumpy ride, we believe Europe's economy looks well set to pick up speed and provide opportunities for investors in 2017.

While recent polls show that only half of European citizens have a favourable view of the EU, and less than a third support further integration, the upcoming elections in Germany and France present an opportunity for Europe's leaders. If the EU holds together following these elections, investors are likely to be encouraged.

The Brexit vote was a wake-up call for European leaders, suggesting there is something profoundly dysfunctional in the union's set-up that needs to be fixed. Given that sentiment is currently very negative, any improvement in the outlook for the region could have a significant impact across the industry, leading to investment inflows and supporting asset prices.

For the past six years, consensus expectations in January for the year ahead have been for around 10% earnings per share (EPS) growth in Europe. Between 2011 and 2016, these growth forecasts have been progressively revised lower to finish the year close to zero.As a result, European earnings are still some 20% below their peak.

However, 2017 could be different, as forecasts have seen limited downgrades so far. For the first time in many years we believe there is more upside than downside risk for European earnings growth.

The commitment from the ECB to maintain very accommodative monetary policies until the region has established a self-sustained recovery benefits the EU in three ways.

First, the central bank's 'whatever it takes' pledge remains firmly in place, providing some downside protection. Second, interest rates will probably remain at a low enough level to support the economic recovery but without jeopardising the financial sector's profitability. Third, the policy divergence between the ECB and a gradually more hawkish US Federal Reserve should prevent the euro from appreciating substantially.

In this context, having some degree of exposure to European equities seems appropriate. It is important to remember that the region represents around 20% of the world's GDP and a similar proportion of global equity market, avoiding it completely can have a significant impact on portfolio performance. Uncertainty is high but this appears to be reflected in the underperformance of the region's equity markets over the past five years. While it may seem prudent, waiting for full clarity can be a costly strategy.

In a world where equity valuations are deemed fair and yields are low, Europe stands out as a value market that generates an attractive dividend yield. European equities are trading at an average price-to-book ratio of just 1.7 times. This compares with 2 times for global equities and represents a discount that is twice the historical average of 10%. At the same time, European equities yield around 4%, a full percentage point ahead of their global counterparts.

Although a number of political flashpoints threaten the region's stability - including Article 50 being triggered on 29th March - the region has proven its ability to endure challenging times. Economic data over the next six to nine months will reveal the full impact of recent events.

In the meantime, the uncertain outlook should not distract investors from seeking exposure to reasonably stable investment trends and companies that may deliver consistent growth. At a time of heightened uncertainty, exposure to large, geographically diversified companies can help offset regional risks.

The economic outlook for Europe is improving, which should support a long-awaited pickup in earnings growth, and despite the challenges, the region remains home to some of the world's strongest companies and a great environment for stock-pickers.

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.