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Europe's Bargain-Priced Shares Draw Fleeting Interest

5 Mar 2017 12:00 pm
By Riva Gold and Christopher Whittall 

European shares are lagging behind the global equity rally despite recovering regional growth and corporate profits, highlighting international anxiety over the continent's fractious politics.

Last year, the eurozone economy kept pace with the U.S. for the first time since 2008, while the region's companies outperformed in the last earnings season. European shares are far cheaper on many valuation measures than those in the U.S.

Yet the Euro Stoxx 50, the eurozone's blue chip index, is up 2.7% in dollar terms this year, compared with a roughly 6.3% increase for the Dow Jones Industrial Average and 6% for MSCI's gauge of world stocks.

Eurozone stocks climbed to their highest levels this week since late 2015 but remain 38% below their peak, even as U.S. indexes have notched fresh records.

Some investors cite ongoing economic challenges, including aging populations and strict labor laws. But the risk of an election that renews existential fears about the eurozone is what is keeping many investors, particularly those outside Europe, on the sidelines, analysts and traders say.

"What's hanging over all our heads is the political uncertainty," said Jim Smigiel, chief investment officer at SEI Investments Co. in Oaks, Pa., who has yet to buy into European shares.

Investors face a run of European elections, including in France, Italy and the Netherlands, in which euroskeptic candidates enjoy a strong showing in polls.

Investors are particularly concerned about France, and the prospect that far-right candidate Marine Le Pen could win presidential elections this spring. Ms. Le Pen has promised to call a referendum on the country's membership in the eurozone.

Most analysts believe that Ms. Le Pen won't win and that even if she does, she'll face many hurdles in triggering a so-called Frexit. But after surprise votes for Brexit and U.S. President Donald Trump, many investors outside of Europe are unwilling to take any chances.

This year, global fund managers view European "disintegration" as the biggest tail risk for markets, according to a recent survey by Bank of America Merrill Lynch. Investors fret that should one country drop out of the euro, others will follow.

There is evidence that U.S. investors started to sell European equities at the start of the year, according to an analysis from Morgan Stanley. Over the first several weeks of the year, European stocks tended to decline more during their afternoon trading session, when U.S. investors are more active, the bank said.

There have been recent signs, including around the Brexit vote and Mr. Trump's election, that suggest investors prefer to stick to more-familiar markets in times of political uncertainty.

Fund-flow data suggest that, in recent months, funds have been more reluctant to invest in Europe than elsewhere. Cumulative flows into U.S. equity funds since early November equate to 8.4% of these funds' total assets, according to BNP Paribas. That has happened as investors plowed money into equities following Mr. Trump's election victory on hopes of higher economic growth. Cumulative flows to European equities came to 2.7% over the same period.

Retail redemptions from Europe equity funds hit their highest level since early November in the last week of February, according to fund-tracker EPFR Global.

In some cases, "people think they don't understand [the French election] enough to take a strong view, and are going to get out," said Isabelle Mateos y Lago, London-based chief multiasset strategist at BlackRock Inc., who doesn't believe that France will ditch the euro.

Accordingly, some say the shares could rise if those fears don't come to pass.

BNP Paribas's so-called Love-Panic index, which weighs investor sentiment, economic data and market data, suggests there is too much pessimism about European stocks and too much optimism about U.S. stocks, said Ankit Gheedia, a strategist at the bank.

The last time sentiment was so skewed toward the U.S. was in December 2014, Mr. Gheedia said, when the eurozone economy entered deflation. That preceded a period of strong market outperformance for European stocks after the European Central Bank announced large-scale asset purchases.

This time around, the eurozone has economic growth on its side.

The currency area's jobless rate is down to a seven-year low, manufacturing growth is at its highest since April 2011 and business confidence recently climbed to its highest since before the financial crisis. French and Dutch businesses appear undaunted by their impending elections.

To be sure, some investors are skeptical that the current economic rebound will last, after several false starts in recent years. Unemployment in the eurozone remains roughly twice that of the U.S., and many southern European economies still have large public debts.

"The economic news in Europe is heartening, but we've seen this movie before," said David Donabedian, chief investment officer at CIBC Atlantic Trust.

Yet some say the numbers are too compelling to ignore. On a price-to-book basis, European stocks are trading near 40-year lows compared with the U.S., according to Bank of America Merrill Lynch. Earnings are looking up too. Bank of America expects earnings-per-share growth in Europe to reach 20% over 2017 and 2018, compared with 16% in the U.S.

"We have a very high conviction that the European growth story is completely misunderstood by international investors," said Christopher Mahon, a London-based director on the multiasset team at Barings, whose strongest allocation is to European equities.

Write to Riva Gold at riva.gold@wsj.com and Christopher Whittall at christopher.whittall@wsj.com

(END) Dow Jones Newswires

March 05, 2017 07:00 ET (12:00 GMT)

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