Optimism about the Eurozone has recently taken a hit. The composite Purchasing Managers' Index for February fell to 57.5 from 58.8 in January, part of a broader trend in the data. The Citi Economic Surprise Index, which measures whether data has beaten or missed forecasts, has fallen from 93 in November to 23, while the Euro Stoxx 50 has lost 2% this year versus a 1.6% gain in the S&P 500 in local currency terms.
But we believe the outlook for the Eurozone economy and stocks remains positive.
- Economic fundamentals are strong. While the composite PMI fell, the reading was still consistent with a growth rate of 0.9% in the first quarter, according to Markit. This would be the fastest quarterly growth in eight years.
- Profits are growing, despite currency strength. The euro has climbed 9% on a trade-weighted basis over the past 12 months which, based on history, translates into a near four percentage point drag on earnings. Even after this, earnings per share rose 8% in the fourth quarter, excluding financials, and consensus forecast is for a further 9% in 2018. Given the strength of the economy this could be conservative, since earnings in the Eurozone typically rise 2.8 times faster than revenues.
- Stocks remain good value versus bonds. The equity risk premium, which measures the excess equity earnings yield over the real bond yield, is 8%. That's higher than the 10-year average of 6%, suggesting stocks are still appealing.
So we remain overweight Eurozone equities versus the UK, where earnings growth is likely to be held back by the revival of the pound, given that 70% of FTSE 100 revenues come from overseas.
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