By Ken Van Weyenberg
A much-improved economic climate, a stabilising debt crisis in the eurozone and sustained accommodating monetary policy have all combined to produce a strong equity rally in recent months. A big reason for this is that the global economy is now recovering. The IMF forecasts global economy growth of just under 3% for 2013 and over 3.5% for 2014.
Some investors may worry they’ve missed the recent boom, but the reality is there are still opportunities for long-term investors to jump aboard the bandwagon. The question investors need to ask themselves is whether they should target the US or Europe?
The recovery has been reflected in the US. Growth in Q2 2013 was around 2.5% and current indicators for US manufacturing and services sectors point to a continuation of economic recovery in the coming quarters. Although the IMF is still relatively conservative on US performance for 2013, it still expects significant growth acceleration in 2014.
The eurozone is also coming back to life. In Q2 2013 the economy clambered out of a recession that had kept the region in its grip for six straight quarters.
Even in the peripheral countries there has been talk of stabilisation and the European Commission’s Economic Sentiment Index suggests the eurozone could again achieve growth of 1% in 2014.
While equity market valuations are attractive across both regions, we prefer the European to the US market. This is due to the region’s good economic momentum, its solid valuations and the reversal of earnings momentum we are seeing.
It is true that the US has experienced positive economic momentum, but the country’s moderate economic growth with the chance of some acceleration next year has already been priced into market projections.
In contrast, the eurozone is still gradually emerging from recession and any further recovery of the economy will oblige many macroeconomists to review their growth outlook upwards.
The potential is clearly higher in Europe and this is shown if we take into account a price-to-earnings ratio that is adapted to reflect the economic cycles. In doing so it is apparent that the US has hit the average long-term rating, while Europe still has some serious catching-up to do.
The potential seen in European equity markets could also be added to by an earnings-momentum reversal.
Up until now, analysts have been revising their earnings forecasts for Europe downwards. The expected rise in profitability for European firms, which is currently at rock-bottom levels, could swing back upwards should the economic recovery continue.
We are also of the belief that analysts’ earnings expectations are too pessimistic at this stage of the economic recovery. This increases the chance of positive surprises that could possibly boost European equity markets in the future.
Ken Van Weyenberg is an investment specialist at Dexia Asset Management
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