Investors are shunning continental European equities, despite improving fundamentals and pricey US stocks, while the UK market has enjoyed a small rebound in sentiment this year.
Funds focused on Western Europe (excluding the UK) have suffered $3.51 billion in net outflows in 2018 to date, as of May 2, according to data from EPFR Global. Indeed, nearly $17 billion has been withdrawn since March 14 this year.
Moreover, the April global fund manager survey by Bank of America Merrill Lynch found that allocations to eurozone stocks had dropped to a 13-month low. This was a function of a wider bearishness on equities, with allocations at their lowest for 18 months.
This trend seems at odds with both generally stronger economic conditions in European Union countries and the stated preference of international fund managers. Respondents to the BofA Merrill survey had said the eurozone was their most favoured region for equities, after emerging markets.
That said, Asian demand for European equities returned late last year and apparently has been strong early this year.
The most recent figures available from eVestment show that Asia-domiciled investors were net buyers of European equity funds in the fourth quarter of 2017 for the first time since Q1 2016. They allocated a net $360 million in Q4, having withdrawn a total of $2.13 billion over the previous six quarters.
According to Ariel Bezalel, head of fixed income strategy at London-based Jupiter Asset Management, Asian investor interest in European equities was strong in February, following price falls at the start of the year.
“There was a perception that European equities were cheap, the path of growth seemed long and the continent was still mid-cycle,” he said.
The Eurostoxx 50 index fell 9% between January 23 and February 9, with the price-to-earnings ratio dropping to 15.0 (the five-year average is 20.1), though it recovered to 16.1 as of May 10.
CONCERNS OVER EUROPE
Fund managers pointed to a host of potential concerns that are deterring greater support from investors in Asia and elsewhere.
David Lewis, an equity manager in the Jupiter Independent Funds Strategy in London, said European equities were less attractive today than a year ago. He cited headwinds including US monetary policy tightening and the European Central Bank’s less accommodative monetary policy “as it progressively steps back from its monthly quantitative easing injections”, as well as higher oil prices.
The ECB cut its bond-buying from €60 billion to €30 billion per month in January.
Concerns about monetary tightening are growing among fund managers generally. BofA Merrill Lynch’s April survey found that a net 74% of European fund managers expected to see higher inflation, up from 66% in March.
Frank Lee, acting chief investment officer for North Asia at DBS Bank in Hong Kong, said the ECB raising rates too quickly was the largest risk for European equities. He also pointed to sovereign debt levels at Europe’s periphery—notably in Portugal, Ireland, Greece and Spain—and said the risk to the UK economy from its exit from the EU could have a knock-on effect in other European markets.
Moreover, Jupiter’s Bezalel argued that Asian investors did not fully appreciate the “tail risk” of a slowdown in the German economy. He pointed to recent US trade tariffs on steel and aluminium imports and said Germany would face pressure over its weak currency, which benefits exporters.
While European stocks appear to have lost their lustre in recent months, some feel certain factors could revitalise international investor interest.
Eurozone unemployment of 8.5% is its lowest level since December 2008, noted Lee. The region could report good GDP growth figures too, he added, but such prospects have not yet been priced into the region’s stock markets. The main reason for that, he said, is the continuing appeal of US equities, following better than expected first-quarter earnings in recent weeks. He also pointed to investors’ perception of sovereign debt risk in peripheral European countries.
However, it is yet not time to pour back in, he said: DBS continues to be underweight European equities and overweight the US, China and Hong Kong.
COUNTRY PREFERENCES
For some investors, getting country-specific in Europe is key. John Woods, Asia-Pacific chief investment officer at Credit Suisse, said he remains neutral on European stocks in general, but is overweight German equities because of cheap valuations and the benefit that market should gain from investors’ current risk aversion.
The firm is also overweight Spanish shares, Woods said. “Spanish economic and earnings downgrades may have run their course; there is scope for Spain to surprise positively on both fronts in coming months.”
Despite gains in recent weeks, Spain’s Ibex 35 index is still 3.7% below its recent high on January 23 and 7.4% below its level a year ago.
Credit Suisse is also overweight European financials because of rising yields and profit growth in this sector, Woods noted, and any rebound in the euro would benefit domestically focused sectors, including real estate, financials, energy and telecoms.
Meanwhile the bank is underweight European consumer staples, which should be adversely affected by current investor risk aversion, said Woods.
UK OPPORTUNITIES
While European stocks have been somewhat out of favour, last year this was doubly the case for UK equities. Institutional investors redeemed $33 billion from UK equity funds between Q3 2016 and Q4 2017, taking out $5 billion in Q4 last year alone, according to eVestment.
But this has left some investors seeing an opportunity. UK equity funds have received a net $1.16 billion in 2018, as of May 2, even after outflows of $2.2 billion since March 14, according to EPFR Global.
Moreover, BofA Merrill Lynch’s April global fund manager survey found that the rotation into UK equities that month was the biggest since the Brexit vote on June 23, 2016.
Lewis confirmed he had been increasing his weighting to UK equities, despite widespread pessimism about the British economy’s post-Brexit prospects. “The opportunities offered by UK equities at these levels could be significant,” he noted.
The FTSE 100 is roughly flat for the year as of yesterday, but is up 11% since 26 March and nearing the record high of 7,778 it set on January 12, 2018. Its p/e ratio stood at 14.2x as of yesterday.
Lewis pointed to an increase in merger-and-acquisition deals among UK companies as an indication that valuation levels are sparking broader investor interest. The value of UK outbound M&A rose from £17.3 billion ($23.44 billion) in 2016 to £76.6 billion in 2017, a 17-year high, according to the UK's Office of National Statistics.
