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Debt Woes No Drag for Europe Stocks as Rally Forecast

Debt Woes No Drag for Europe Stocks
A trader works in front of the DAX index curve at the Frankfurt stock exchange in Frankfurt. Photographer: Ralph Orlowski/Bloomberg

European equities will climb 12 percent through the end of next year, beating 2010’s gains, as rising earnings and record-low interest rates help companies overcome the sovereign-debt crisis, a Bloomberg survey of 13 strategists shows.

Goldman Sachs Group Inc., the most bullish forecaster, says the Stoxx Europe 600 Index will rally 20 percent because profits may expand twice as fast as the 14 percent average rate in more than 26,000 analyst estimates compiled by Bloomberg. Bayerische Motoren Werke AG and WPP Plc, the world’s biggest advertising company, may boost income by an average 18 percent next year, according to data compiled by Bloomberg.

“People have issues with continued earnings growth and our view is don’t be surprised if profit margins continue to expand,” said JPMorgan Chase & Co.’s London-based strategist Mislav Matejka, who predicts European stocks will climb 12 percent by the end of 2011. “We think the pace of earnings growth expected by analysts could actually be too low.”

Companies in Europe are expanding even as concern mounts that the region’s weakest economies will struggle to fund deficits. BMW in Munich, the world’s biggest maker of luxury cars, said Nov. 23 it will shorten Christmas breaks at factories because of increasing demand for new models. Dublin-based WPP reported third-quarter revenue in October that topped analyst estimates as advertising recovered.

German Growth

Germany, Europe’s largest economy, raised its 2010 growth forecast on Dec. 3, three days after the cost of insuring against default on Spanish, Irish and Portuguese government debt rose to records. German business confidence surged to a record in November and retail sales jumped the most in almost three years in October.

The benchmark Stoxx 600 has advanced 8.8 percent this year as the U.S. Federal Reserve pledged up to $600 billion of bond purchases to support the world’s largest economy. The gain trails the 11 percent advance in the Standard & Poor’s 500 Index. Europe is forecast to expand by 1.7 percent next year, according to the International Monetary Fund.

The Stoxx 600 climbed for a fifth day today, rising 0.1 percent to 276.2 at the 4:30 p.m. close in London for its longest stretch of gains since July. The measure is at its highest level since September 2008.

The Fed’s policy, below-average bond yields and a “sweet spot” for European earnings will spur a rally, said Ian Richards and Graham Bishop at Royal Bank of Scotland Group Plc, the third-most bullish forecasters with a 16 percent prediction for the Stoxx 600.

Zero Inflows

While funds that focus on equities worldwide tracked by the Investment Company Institute in Washington lured no net investment in the second quarter, the most recent period for which data is available, bond funds attracted $106 billion.

“Asset allocation money has deserted the equity market,” Richards and Bishop wrote in a Nov. 15 report. “The corporate sector can use the low cost of debt to drive shareholder returns” even without funds coming into the stock market, they said.

Analyst estimates compiled by Bloomberg show annual profit growth in Europe will average 46 percent in 2010 and 2011, more than at any time in the previous seven years. Deutsche Bank AG in Frankfurt, Germany’s largest bank, may expand profit by 45 percent in 2011, estimates compiled by Bloomberg show. Paris- based Cie. de Saint-Gobain SA, Europe’s biggest supplier of building materials, might boost earnings by 28 percent, the data show.

Earnings Yield

The earnings yield for Stoxx 600 companies, or profit as a proportion of the share price, is 6.53 percent, data compiled by Bloomberg show. That’s 3.6 percentage points more than the yield on 10-year German government bonds. The spread reached 4.81 points in August, the highest since the financial crisis in 2008.

The valuation favors equities, according to Goldman Sachs. The New York-based bank recommended on Dec. 1 that investors buy companies with sales in the largest emerging markets and those in core European economies such as Germany.

Morgan Stanley cited Germany and the U.K. as the best countries in Europe for investment. Economic growth may exceed bond yields in both countries, a bullish signal for shares, the bank wrote in a Nov. 29 report. Ten-year German bunds yield 2.93 percent, compared with estimated 2010 GDP growth of 3.5 percent, data compiled by Bloomberg show.

‘Pushed Around’

UBS AG’s London-based strategists Karen Olney and Nick Nelson recommended Italy and France last week, countries they said have been “pushed around by sovereign fear” while having “improving earnings momentum.” France’s CAC 40 Index and Italy’s FTSE MIB are trading at or less than 10 times 2011’s estimated earnings, compared with a valuation of 11 for Germany’s DAX, according to Bloomberg data.

Strategists’ forecasts for an 11 percent gain in European equities in 2010 have proved too optimistic as the region’s government-debt crisis eroded confidence. The Euro Stoxx 50 Index of the biggest euro-area companies has lost 4.2 percent so far this year, while the Stoxx 600, which includes non-euro nations, has risen 8.8 percent.

Stocks in Europe’s most-indebted countries and increased price swings pushed Europe’s benchmark gauge of stock-market volatility to a five-month high last week. Those trends are likely to continue next year, Goldman Sachs said.

Bailout of Ireland

The VStoxx Index, which measures the cost of protecting against a decline in the Euro Stoxx 50, climbed 33 percent in November for the biggest monthly advance since April as a European Union-led bailout of Ireland failed to reassure investors that the debt crisis will be contained. Spain’s IBEX 35 has fallen 15 percent in 2010 and Greece’s ASE has tumbled 31 percent, making them the worst performers among 24 developed markets tracked by Bloomberg.

Tammo Greetfeld, Frankfurt-based strategist at UniCredit SpA, says the Euro Stoxx 50 Index may fall to 2,400 by mid-2011, hurt by the sovereign-debt crisis and cost-cutting measures within euro-region economies. The benchmark measure for stocks in the euro area closed at 2,839.53 today.

Government liabilities as a proportion of gross domestic product climbed in Europe this year on spending to improve the economy and bail out banks. EU government debt reached 77.5 percent of GDP this year from 58.5 percent in 2007, according to data from the IMF. The ratio will reach 82 percent in 2012, IMF data show.

‘Still Improving’

“Necessary reform measures to stabilize the euro zone pose short-term risk to growth,” Greetfeld said in a Dec. 3 interview. “Rising tensions within the euro zone and the risk of a further escalation should weigh on the overall equity market.”

In Germany, where the DAX has soared 18 percent so far this year, the Bundesbank last week raised its forecast for 2010 growth to 3.6 percent. The Organization for Economic Cooperation and Development and the IMF both forecast the global economy will expand 4.2 percent next year.

“Global economic growth is still improving, which therefore underpins stock markets in the medium term,” said Kevin Lilley, a fund manager who helps oversee about $2 billion at Royal London Asset Management in the U.K. capital. “In all of the models I run, there is still substantial upside to equity markets. I am not comfortable with the short-term volatility but I am sticking with the view that global GDP growth remains pretty robust.”

Morgan Stanley’s London-based strategist Graham Secker said that while volatility in markets will remain high until a “comprehensive solution” to the debt crisis is found, he still sees stocks gaining about 7.3 percent through 2011.

“We don’t think the global bull market is over,” Secker said at a press briefing in London on Nov. 30. “There will be an opportunity to sell the market in the next one or two years but that opportunity is not now.”

The following is a table of strategists who have given 2011 forecasts for indexes. Implied gains from last week’s close are in parentheses.

Brokerage           Strategist         Index    Forecast
RBS                 Richards/Bishop    SXXP     320   (+16%)
Morgan Stanley      Graham Secker      MSDLE15  1,250 (+7.3%)
UniCredit           Tammo Greetfeld    SX5E     2,900 (+2.1%)
Goldman Sachs       Peter Oppenheimer  SXXP     330   (+20%)
JPMorgan            Mislav Matejka     MSDLE15  1,310 (+12%)
BofA Merrill Lynch  Gary Baker         SXXP     300   (+8.7%)
Societe Generale    Claudia Panseri    SXXP     310   (+12%)
Deutsche Bank       Gareth Evans       SXXP     315   (+14%)
Exane BNP           Jansen/Kreckel     SXXP     305   (+11%)
Macquarie           Matthias Joerss    SX5P     2,850 (+9%)
Commerzbank         Team               SX5E     3,200 (+13%)
Barclays            Edmund Shing       SX5E     3,350 (+18%)
HSBC                Garry Evans        SXXP     315   (+14%)
UBS*                Nelson/Olney       SXXP           (+16%)

     *UBS has forecast 16 percent gains for the Stoxx 600
excluding dividends for 2011.

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