The year 2016 has been particularly unpredictable for investors, which is not surprising if we take into consideration that it has been a year of important geopolitical events, such as Brexit or the US Presidential Election. Equity markets saw a noteworthy sector rotation: sectors such as consumer staples and energy significantly outperforming in the first half of the year. The unexpected outcome of the British referendum was a turning point for equity markets: financials started to outperform as valuations reached extreme levels and inflation expectations started to rise. Events like this can have repercussions on the performance of the equity markets.
Forecast for 2017?
It is safe to assume that European equities have an excellent opportunity to break out of the trading range where they have been stuck for the past couple of years. We therefore highlight three reasons to be optimistic for the asset class in 2017.
Valuations look Attractive
As usual with equities, the price payed is a key determinant of the potential returns to be made. European equities maintain their attractiveness from a valuation standpoint. The cyclically-adjusted price-to-earnings ratio currently stands at around 14x versus its 30-year average of 20x. We therefore feel that Europe looks attractive relative to its own historical average as well as compared to other regional stock markets. Europe undoubtedly has a difficult political calendar to navigate in 2017 given important elections in France, Germany and the Netherlands, as well as major uncertainties over the Brexit negotiations. However, the market uncertainty and volatility present opportunities for investors to buy well performing companies at attractive valuations in Europe.
Earnings improvement
The year 2017 could see an enhanced growth rate for European corporate earnings, perhaps the fastest for the past five years. Bond yields are indicating a pick-up in inflation expectations, which is typically positive for an earnings recovery. The energy, commodity, utilities and chemicals sectors have seen positive earnings revisions over the last three months, after years of being heavily affected by the global economic slowdown and political uncertainties. It is noteworthy, for example, that crude oil is being traded now at over 50$/barrel after the historic agreement between Opec and non-Opec oil producing countries in November 2016. Also, the largest European energy utilities are seeing a steady recovery in earnings, after years of restructuring. The low interest rates and monetary easing is also supporting the recovery in the industry.
Renewables
The renewables and alternative energy are the spaces where we see the highest potential. This covers abroad spectrum stretching from electric vehicles to wind power. This is an area where a long-term view is needed as new technologies take time to become commercially viable. As the energy policy of the United States under the Trump Presidency seems to bring an increasing focus on conventionals, Europe is expected to continue to provide incentives in order to keep and deepen its competitive edge in this sector. Public support for renewable energy has never been higher. A recent poll carried out by TNS in all EU countries concludes that 91% of Europeans say it is important that their government sets targets and provides support to increase the amount of renewable energy used by 2030. As a consequence of sustained political will and public support and amid global slowdown, Europe has seen a record high in investments in offshore wind in 2016, of $19.5 billion.
To sum everything up, the political outlook of 2017 will provide an environment that is rich in investment opportunities, driven by the probable sentiment swings in the market. Valuations remain compelling and the slow economic recovery in Europe should provide a solid backdrop for corporate earnings to deliver potentially their best growth rates for five years. Correlations are at elevated levels although there are signs that the momentum is changing, driven by the pick-up in bond yields.