July was a very strong month for European equities, rising by over 8 per cent, outpacing most other markets including the US, maintaining the strong momentum of the first half of 2013.
It is perhaps stating the obvious that the European sovereign debt crisis has been largely to blame for the long period of uncertainty that has made investing in equities an unrewarding exercise since early 2010, when the Stoxx Europe 600 was nearly at the same level that it is currently.
But recently a number of strategists have said there may be more than a little light at the end of the tunnel for the European economies. Recent Purchasing Manager Index surveys have started to raise expectations for a return to growth in the latter part of 2013 and early 2014.
Ever since the shock of the 2008 financial crisis, chief execs world-wide have run companies in a conservative fashion, distrustful of the politically-inspired nonsense in the US and Europe that has delayed a sustained return to confidence. In the US, this led to the accumulation of trillions of dollars on company balance sheets, which have more recently found their way into investors’ pockets via increasing equity dividends, helping a sustained rally and outperformance of US stocks.
But in the same period many European companies have been battling with no growth and even less confidence. Yet some equity strategists are turning more optimistic about European markets, anticipating that they will continue their recent recovery and close the substantial valuation gap that has opened up against the US market, which now sells for over 15 times 2013 earnings.
One factor that may encourage outperformance in European markets would be if local companies could gain from improved conditions in their own economies. Admittedly, today so many companies are truly global that an improving European economy will likely benefit most international companies. However, any such improvement will be more advantageous to local European stocks.
Another factor is a continued increase in confidence in financial stocks. In the US, financials represent 18 per cent of the S&P 500 whereas in Europe it is an even more important 22 per cent, of which nearly 13 per cent is the banking sector, compared with just 6.5 per cent in the US. Recent results have encouraged investors that the banks are on the mend.
Clearly Europe is not without risk. But if the recent improvement in economic data continues, financially robust companies may echo the recent performance of the US, and this could be the start of a period of sustained outperformance for European equities.
Tim Gregory is head of global equities at Psigma Investment Management