Europe’s Rallying Stock Market Leaves Many Investors Skeptical
European stocks are enjoying their best start to a year since 2015, sparking concerns that threats such as slowing growth and a disruptive Brexit could bring the rally to a skidding halt.
The Stoxx Europe 600, which tracks large, mid- and small-cap stocks, has gained 10.3% in 2019, putting it on course for its best combined January and February in four years. The index is within striking distance of surpassing the S&P 500, which is up 11.4%.
Analysts attribute the rebound to relief that the Federal Reserve and European Central Bank look likely to push back interest-rate increases while they gauge the slowdown in the global economy, as well as to optimism about the U.S. and China’s trade negotiations. European companies are more exposed to global trade than their U.S. counterparts.
Despite the rally, a number of money managers are skeptical the gains can last. The U.K.’s relationship with the European Union remains unresolved a month before the U.K.’s scheduled departure. Spain is set for snap elections in April that could see the hard-right Vox party emerge as kingmaker, and Italy’s governing coalition of antiestablishment parties remains unstable.
“Because of the unresolved uncertainty about Brexit and Italy, the rally hasn’t gone as far as it might have,” said Shep Perkins, chief investment officer for equities at Putnam Investments, which manages $170 billion. He hasn’t bought into European stocks as they have staged a comeback, saying they face greater challenges than shares in markets such as Japan.
For U.S. money managers, investing in European stocks has also been lucrative: In dollar terms, the Stoxx 600 is still up 10%, because the greenback has largely held its own against the euro. Exchanges have rallied across the continent, with particularly strong showings in Italy, Sweden and Switzerland.
Still, rising share prices haven’t drawn fresh money into retail equity funds. For the past six weeks, and for 45 over the past year, mutual and exchange-traded funds that track European stocks have seen more money flow out than in, according to Lipper.
Hedge funds are no more convinced. Based on its own prime-brokerage business, Morgan Stanley says their exposure to European shares has barely risen this year and remains very low.
One factor keeping investors cautious: As U.S.-Chinese trade tensions simmer down, Europe’s own relations with the U.S. are coming to a boil. On Feb. 20, President Trump described the EU as “very difficult over a period of time, over many, many years” and said he could impose tariffs on autos from the bloc.
New trade levies would add to pressure on Europe’s car industry, whose travails were partly responsible for stalled growth in Germany in the second half of 2018. IHS Markit says its purchasing managers’ indexes suggest that the eurozone will expand by about 0.1% in the first quarter of 2019 compared with the fourth quarter of 2018 and that the U.K. will grind to a halt or go into reverse.
Some fund managers spy an opportunity in the prevailing gloom about Europe. Elias Cohen, who manages Neuberger Berman’s International Equity Fund from New York, is overweight European stocks, with Dutch semiconductor maker ASML Holding NV as the fund’s largest holding.
“There’s way too much bearishness in Europe,” he said. “Valuations point to a recession. But it’s really only sentiment that points that way, not the hard economic data.”
Another factor working in European stocks’ favor: They look relatively cheap. Even after the recent advance, the Stoxx 600 trades at around 13.5 times forecasts of earnings over the next year, versus 16.4 for the S&P 500. American stocks tend to trade at a premium, partly thanks to the presence of large technology firms that command huge multiples.
Still, for some investors and analysts, the threat of further political shocks or another deceleration in economic growth is keeping them reluctant to place bets on Europe. Companies in the Stoxx 600 are expected to report earnings growth of 2.6% in the fourth quarter from the same period a year earlier, according to Lipper, down from 14% in the third quarter and 10% in the second quarter.
“Volatility has to go up from here, given what’s going on in Europe,” said Mark Grant, managing director and chief global strategist at B. Riley FBR.
Source: Dow Jones