Europe is leading from Behind thus far in 201408-21-2014 |
In an earlier blog posting this year, we forecasted a high, single-digit gain for the S&P 500 index over the course of 2014 but contended that U.S. stock market returns would likely be outpaced in 2014 by certain International – Developed Country stock market returns (notably Europe) as regions such as the Eurozone continue to emerge from their own recession. At that time, Europe looked particularly compelling to us given the following:
- Their stock valuations look attractive both on a historical basis and, relative to U.S. stocks
- The region’s economy is gradually improving
- Europe’s central bank, The European Central Bank (ECB), continues to promote growth through its own accommodative monetary policies
With respect to the last bullet point, the ECB cut its benchmark interest rate in June 2014 to just 0.15% from 0.25% and we continue to believe that they will keep rates low (even introducing negative interest rates) in an effort to help stimulate further growth in the Eurozone and stave off the risk of deflation in the region. The overall, coordinated economic recovery process in Europe is reminiscent of the early stages of the U.S.’s own quantitative easing program and therefore we expect to see additional inflows of overall investment to the region over time.
Many expected 2014 to show more signs of continued progress in terms of economic growth across Europe. To this end, according to a March 2014 article in The Irish Times entitled, “Merkel upbeat on euro zone growth potential in 2014”, the European Commission had forecasted annual growth of 1.2% for the Eurozone in 2014 and 1.5% for the more encompassing European Union.
However, thus far in 2014, the European stock market story has been lagging its U.S. counterpart (see chart below), plagued by factors such as geopolitical concerns in Iraq and Ukraine and troubling economic reports from some Eurozone countries including Germany (Europe’s largest economy), France (Europe’s second largest economy) and Italy (one of the debt plagued P.I.I.G.S. countries in Europe).
Stock Market Index 2014 YTD Total Return % as of 7/31/14 S&P 500 Index (U.S.)1 5.66% FTSE 100 Index (London)2 1.95% DAX 30 Index (Germany)3 -1.51% Euro Stoxx 50 Index (Europe) 4 3.16%
Source: Bloomberg, as of July 31, 2014. Past performance is not indicative of future results. You cannot invest directly in an index.
1S&P 500 Index – Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
2FTSE 100 Index – The FTSE 100 Index is a capitalization-weighted index of the 10 most highly capitalized companies traded on the London Stock Exchange.
3DAX 30 Index – This German Stock Index is a total return of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange.
4Euro Stoxx 50 Index – The Euro Stoxx 50 Index is Europe’s leading Blue-chip index for the Eurozone provides a Blue-chip representation of super sector leaders in the Eurozone. The index covers 50 stocks from 12 Eurozone countries.
Thee recent disappointing economic reports (some of which can be attributed to poor weather in the 1st quarter and some of which can be attributed to recently imposed economic sanctions by Russia) should not be misconstrued as proof that Europe is falling back into a prolonged period of recession. As with the Federal Reserve in the U.S., the ECB stands at the ready to provide more stimulus to keep the European economic recovery alive. In addition, earnings growth is a key component of Europe’s economic recovery process and analysts predicted leading into this year that European profits will grow by 30% and climb back to their 2007 highs by 2016 in a MarketWatch article entitled, “Europe will beat U.S. in stock-market throwdown, the biggest banks predict”. Absent any major geopolitical event(s), or escalation(s) of existing turmoil in areas such as the Ukraine/Russia, within the region, we would not count Europe out just yet and still contend that international markets may offer more upside potential over the intermediate term when compared to the U.S. markets – which we still believe are within the midst of a secular bull market which may see intermittent periods of short term volatility but still have a general upward bias over the short-intermediate term.
Once the Russia/Ukraine crisis abates and the Russian imposed sanctions are lifted, low valuations, continued strong central-bank support and anticipated solid earnings growth are all likely to catapult Europe from its current “leading from behind” position to a “leading from the front of the global pack” position. This should attract investors’ attention and investment flows again. As a result, we believe that European equities are worthy of strong consideration at these valuations. We are not alone in this viewpoint as J.P. Morgan Cazenove commented in a MarketWatch article entitled, “European stocks rise as Ukraine tensions ease” that the DAX 30 Index is “now the cheapest market in Europe,” at 11.9 times price-to-earnings, and is a “beneficiary of a falling euro and of a pickup in Chinese and U.S. activity”.
Disclosure: Hennion & Walsh Asset Management currently has allocations within its managed money program and Hennion & Walsh currently has allocations within certain SmartTrust® Unit Investment Trusts (UITs) consistent with several of the portfolio management ideas for consideration cited above.