June 2017

Eurozone: Three Forces Driving the Rally

BlackRock has a positive view on
European equities (ex-UK)

After underperforming US equities for the better part of this decade, Europe has rebounded strongly in 2017. Many investors with a "once bitten, twice shy" mentality to international investing may have missed the story underpinning this outperformance. Following outflows of $34B in 2016, European ETPs have seen $20B of inflows globally in 2017.1


1Reflation is going global; we see particular benefits for Eurozone stocks
BlackRock sees upside to the current consensus 12-month global growth estimates. In particular, we see the traditional powerhouses of European growth like Germany and France (who together account for half of Euro area GDP) as likely to surprise to the upside of the consensus estimate. Together with a lessening of political risk in Europe, leading indicators like PMIs, demand for loans and sentiment surveys are all pointing higher, which suggest a sustained improvement. Lastly, as illustrated in Exhibit 1 below, Eurozone stocks tend to be particularly sensitive to changes in GDP; continued global growth might disproportionately benefit this category.

Exhibit 1: Earnings beta to Industrial Production

Exhibit 1: Earnings beta to Industrial Production

Source: BlackRock Investment Institute, Thomson Reuters, as of May 19, 2017.
Notes: The index represented is the MSCI European Economic and Monetary Union (EMU) index and MSCI USA index.
The bars represent the beta of selected MSCI indices' 12-month trailing earnings and changes in world industrial production.


2Earnings surprises are part of a longer-term trend
The ratio of Eurozone earnings upgrades relative to downgrades, an indicator of analyst bullishness, is currently at its highest level since 2010. Net upgrades are still rising (12 consecutive months and counting), coinciding with the best Eurozone earnings season for beats in 7 years. Profitability estimates for European corporations have been improving since last summer, but are still nearly 50% below their peaks pre-crisis, suggesting there is still ample room for improvement.

Exhibit 2: Earnings improvement in the Eurozone

Exhibit 2: Earnings improvement in the Eurozone

Source: IBES, Thomson Reuters, Citi, as of May 19, 2017.
Notes: The index represented is the MSCI European Economic and Monetary Union (EMU) index. Earnings revision ratio is a 3 month moving average. Forward earnings are based on IBES estimates.


3Valuations are attractive after years of underperformance
With quantitative easing ongoing in Europe, valuations are still attractive relative to historical levels. The MSCI Eurozone ranks only in the 66th percentile of its historical valuation, and forward P/E levels are 11% below their 2015 peaks.2 By contrast, the S&P 500 ranks in the 80th percentile of its historical valuations (with forward P/E levels at 2001 tech bubble levels).2 In forward P/E terms, Europe is also at a 16% discount to the S&P 500, and a 7% discount to the MSCI ACWI. Moreover, in terms of price to book values, Europe is at an even steeper discount (47% vs. the S&P 500 and 26% vs. the MSCI ACWI).2 As Exhibit 3 shows, regional stock performance tend to go in multi-year cycles, and the Eurozone’s YTD performance might be the start of a longer trend.

Exhibit 3: U.S. versus Eurozone equities

Exhibit 3: U.S. versus Eurozone equities

Source: Thomson Reuters Datastream, BlackRock, as of May 18, 2017
Notes: The bars represent the monthly return difference in the S&P 500 Index and the MSCI EMU index. Index returns are for illustrative purposes only. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.


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