Buoyant Europe Stocks Turn Out to Be ‘Pain Trade’ of First Half

  • Large-cap index has outperformed S&P 500 in dollar terms
  • 2017 a ‘breakthrough year’ for European earnings: NN IP’s Bos

No populist victory, no deflation, no widespread banking crisis.

Shunned by investors for most of 2016 and early 2017 due to political and economic unease, European stocks emerged among the best investments of the first half of this year for dollar investors, sending portfolio managers scrambling to deepen their exposure to the recovering region.

The Euro Stoxx 50 Index surged 13 percent in dollar terms in the first half of the year, versus about an 8 percent increase in the S&P 500 Index. The gauge of the region’s biggest companies -- including Siemens AG, Sanofi and Telefonica SA -- got a boost from gains in the euro. In local currency, it rose 4.6 percent.

Southern European markets have been on a tear in dollar terms: Spain’s IBEX 35 and Portugal’s PSI 20 climbed 19 percent or more in the first half, Italy’s FTSE MIB rose 16 percent and Greece’s ASE jumped 38 percent.

After burning their fingers in 2015, many investors were reluctant to come back to the region, spooked by this year’s elections in countries including the Netherlands and France. But with the anti-Islam Freedom Party defeated in the Netherlands and the victory of pro-European Union Emmanuel Macron in France, the region’s equities have become a “pain trade”: hurting fund managers who have had an underweight holding of the stocks.

“The rise of populism was halted in Europe,” Jeroen Bos, head of equities at NN Investment Partners, wrote in a June 29 note. “Although political risk in the euro zone has not disappeared, we believe that compared to developments in the U.S., Latin America and several other regions, Europe could now even be classified as relatively stable from a political perspective.”

Now that political risks are abating and the economic recovery seems solid, investors are rushing back to Europe and switching out of U.S. stocks. European equity funds saw net inflows of $2.4 billion in the week to June 28, marking a 14th straight week of inflows. U.S. equity funds saw outflows of $5.2 billion over the same period, with redemptions seen in seven of the past nine weeks, according to Bank of America-Merrill Lynch strategists, citing EPFR Global data.

Unlike in the past few years, no major disappointments have emerged so far on the earnings front in 2017. With the second-quarter season set to start soon, profit at European companies is expected to rise 12 percent from the year-earlier period. And although analysts have just started to trim 2017 estimates in part to adjust for lower commodity prices, European banks continue to see earnings upgrades, according to Morgan Stanley equity strategists including Graham Secker.

“2017 is a breakthrough year for corporate profitability in Europe, marking the end of a prolonged profit recession in the region,” NN IP’s Bos said.

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