Yet Another Letdown Has European Stock Bulls Pining for 2018By
European equities are once again frustrating strategists.
While the Stoxx Europe 600 Index has risen 5.7 percent this year, that’s not even half the gains clocked by U.S. and Asian peers. The region’s advance gives little credit to improving profits and economic strength, according to Citigroup Inc.’s Jonathan Stubbs, who says evidence that growth can be sustained should lift the gauge by another 20 percent through 2018.
Waiting for Europe to deliver on returns has taken on elements of the absurd for equity bulls. While the region has shown a long-awaited earnings recovery, with profits on track to expand for a sixth quarter, investor confidence has been slow to return. Stock funds have recovered just 38 percent of the $110 billion they bled in 2016, according to Bank of America Corp. reports citing EPFR Global data. Shares are still far cheaper than when the index last hit a record in 2015.
“Investors are not in the mood to get aggressively ahead of the curve,” Stubbs, an equity strategist at Citigroup, said by phone from London. “They’re pricing out downside macro risks, but not necessarily pricing in the good news. Europe’s obviously been an arena of disappointment for many years.”
Analysts are underestimating European companies’ capacity to increase their profits next year, according to Stubbs. While fund managers say evidence of double-digit earnings growth would be the most important catalyst to bring risk appetite back to Europe, only a small majority now believe it will happen, according to a Bank of America survey published this week.
Earlier this year, it looked briefly as though skeptics would be punished. With strategists calling for muted gains at best, the Stoxx 600 had leapt ahead of the most optimistic 2017 forecast by April. But a strengthening euro derailed the rally soon after, and a less-than-convincing earnings season has damped the mood in November.
Analysts have trimmed their profit estimates for Europe almost every week since June. That has kept dip buyers away from the region’s stocks, with a seven-day loss wiping almost 400 billion euros ($471 billion) off the value of Stoxx 600 members through Wednesday. The benchmark advanced 0.8 percent on Thursday, halting its longest losing streak in a year.
UBS Group AG says a 10 percent increase in profits next year will help lift the Stoxx 600 to 440 points -- or 15 percent higher than Wednesday’s close -- even if the euro strengthens to $1.25.
A scarcity of technology stocks has hurt the benchmark’s performance relative to U.S. equities, which have been boosted by a surge in the so-called FAANG stocks. The European gauge will benefit next year from its heavy gearing toward banks as bond yields rise, UBS strategists including Nick Nelson wrote this week. Lenders comprise about 14 percent of the Stoxx 600.
Deutsche Bank AG’s strategists led by Sebastian Raedler are less optimistic, predicting in a Nov. 15 note that European stocks will continue to lag those in the U.S., with further strength in the euro limiting profit growth next year. Their target for the Stoxx 600 at the end of 2018 implies just a 3.4 percent gain from Wednesday’s close.
In a sign that bulls have not entirely given up on Europe, all of the region’s major national benchmarks have held on to gains for the year, and those in Italy, Germany and Austria are up at least 13 percent. While the Stoxx 600 should fare better than the S&P 500 Index in 2018, investors used to disappointment in Europe will need convincing, according to Kay Van-Petersen, a global macro strategist at Saxo Capital Markets Pte in Singapore.
“It’s by no means game over for European stocks, but I’d say the easier days of strong macro data combined with a weak euro are gone,” Van-Petersen said by phone. “For 2018, it’s really going to come back down to central banks and how the euro will move.”