Year of the Dog: Are EU and UK stocks a good bet?

The rapid rise of equities in the US throughout 2017 and into early 2018 left many investors wondering how much more upside was left in the market—with some justification, as the late January and early February corrections revealed.

It also led fund managers to wonder whether there was better returns to be found in other markets, and in particular Europe, where corporate earnings and economic growth has been showing signs of improvement. Of course, one uncertainty in all this was the UK's coming Brexit. As a result, for our Year of the Dog predictions we asked: 

Are European and UK equities a good bet this year?

Europe: Yes 

UK: No

The UK and the European Union’s forthcoming messy divorce is driving equity investors’ thinking. Their most common broad approach for 2018 seems to be: overweight Europe, underweight the UK.

Mike Bell, global market strategist at JP Morgan Asset Management, even stated in mid-January that UK stocks were the least attractive across all global markets this year. This is despite the FTSE 100 only gaining 7.1% last year, lagging the Stoxx Europe 600, which climbed 8.8%. 

Certainly, Brexit remains the biggest political elephant in the room for the continent, with just over a year to go before the UK withdraws from the EU on March 30, 2019. 

Uncertainty reigns over key issues such as UK access to the single European market, how customs borders will be dealt with and the movement of citizens between the two. Full clarity seems unlikely until much closer to zero hour.

What’s more, a common point of agreement among investors is that Brexit—whatever shape it takes—will be bad for the UK.

The country’s growth is forecast to slow again this year after falling to 1.8% in 2017 from 1.9% in 2016, according to both the International Monetary Fund and the Office for Budget Responsibility, the British government’s independent forecaster. Inflation is also expected to fall after hitting 3.1% last year. Despite this, markets expects to see two 25-basis-point interest rate rises during the year.   

That said, the FTSE 100 index contains many multinationals that generate huge revenues overseas, well beyond Europe, such as HSBC, oil producer Royal Dutch Shell and drug maker GlaxoSmithKline. These are likely to remain attractive at a time of global economic growth, regardless of where their head offices are situated.

Investors are far more positive on continental European stocks, amid an improving macro economic backdrop. 

European Central Bank (ECB) stimulus in the form of asset purchases should continue until at least September, and it has stated it will not raise interest rates until “well past” ending the programme. And despite pressure from Germany, ECB governor Mario Draghi has intimated that he will tighten monetary policy fairly slowly.

Moreover, European corporate earnings are on the rise and manufacturing activity at its highest for several years. Investors note the eurozone’s economic recovery is three to four years behind the US’s, suggesting more economic upside. Plus European valuations look more reasonable. The Stoxx 600’s price-to-earnings ratio for 12 months ahead stood at 16.19 times on January 1, versus 20.54 for the US’s S&P 500 (and 14.70 for the FTSE 100), according to Factset data. 

Barring more major populist upheavals, continental Europe looks a good bet. The UK less so. 

Previous Year of the Dog predictions:

Will the US Treasury yield curve invert?

Will Donald Trump still be president at the end of 2018?

What will be the best performing asset class, on a risk-adjusted basis?