After the excellent performance of European equity markets in the first quarter this year, the Euro Stoxx 50 suffered a drawdown of 14 per cent due to uncertainty of whether Greece would remain part of the Eurozone.
Many investors turned risk averse when market volatility increased. However, those who had the courage to pick up beaten down stocks benefitted from a rebound of 10 per cent in a very short period of time as investors became more convinced that a deal was on the table.
With hindsight, it was a no brainer to top up your positions which were ‘on sale’ for a short period of time. With contagion risk being unlikely in peripheral European countries (mainly Italy and Spain) which are reporting improving economic and the majority of Greeks (at least 75 per cent) wanting to remain in the Eurozone, the probability was skewed towards an agreement between Greece and its creditors.
If you think about it, how many times will you be able to pick up a company like Allianz at a 20 per cent discount from its high giving you a dividend yield of over five per cent? And if Greece had to leave the Eurozone, how bad could it have been for Allianz?
We are talking about a country with a nominal GDP of €180 billion. There are companies like Volkswagen, Glencore, BP, Royal Dutch Shell etc. which generate revenues greater than that.
Now that Greece is out of the picture (at least for the time being), we can go back to the drawing board and focus on what’s most important; equity valuations.
The following are what I expect to be tailwinds for European equities:
A weak euro
When there was doubt whether Greece will continue to form part of the monetary union, we continued to see downward pressure on the value of the euro.
Now Greece is out of the picture, however, the euro remains under pressure due to a potential rate hike in the US.
Whichever way you look at it, there are no catalysts for a stronger euro currency at least for the rest of the year.
The positive is that a weak euro is beneficial for European companies because it makes exports cheaper. Looking at valuations in H115, European companies reported strong growth in revenues, 10% of which was just due to a weaker currency.
Signs of an improving European economy
In the first six months of the year we have seen positive economic data come out of the Eurozone. For example whereas Europe was in a deflation environment in December 2014, an inflation rate of 0.2 per cent was reported for the month of June. This positive data has been seen across the board. We have seen an increase in GDP, wages, house prices and a decrease in the unemployment rate.
Nothing to blow trumpets about but you must appreciate that quantitative easing has just started and we are already seeing positive date. All of which is beneficial for European corporates.
Weaker price of commodities
Commodity prices have been coming down. Over a one-year period, the Bloomberg Commodity index fell by more than 26 per cent. Although there are different reasons affecting the price of different commodities, a common factor in all commodities is a slowdown in demand from China due to building up of inventories in previous years. This applies to copper, aluminium etc.
Companies benefit from weaker commodity prices as their costs decrease. A sector which benefits from a weaker price of commodities is the auto sector. Not only do costs decrease but they also see a demand increase as the costs of fuel remains low. Companies in the auto sector which we particularly like are Valeo, BMW and Renault.
Attractive earnings yield
A lot of European Blue Chip companies are trading on attractive current earnings yield. Without factoring in an improvement in earnings going forward, companies like Volkswagen, BMW, Allianz Daimler, RWE and AXA are trading on earning yields of 11.5 per cent, 9.3 per cent, 9.1 per cent, 8.5 per cent and eight per cent respectively.
This is very attractive especially when compared to the 10-year bund which is currently yielding 0.75 per cent.
Conclusion
I expect European equities to continue to generate attractive returns in the years to come. With an improvement in the outlook for Europe, global growth picking up and external factors like weak commodity prices, European equities are gear to outperform other asset classes as we move towards to end of the year and beyond.
Disclaimer: This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.