European stocks have just accomplished something they have done only once in five years — beat their US counterparts.
It is a vindication of sorts for investors and local strategists, whose bullish estimates of how far Mario Draghi would push equities last year proved too optimistic.
The STOXX Europe 600 Index rose 6.8 percent last year, less than half its average annual return since global equities bottomed in 2009 and falling short of the 14 percent gain forecast by banks and brokerages a year ago. At the same time, viewed against what was available in equities elsewhere, it was the best showing in a decade.
“It’s a decent return for a difficult year,” Copenhagen-based SEB AB head of cross-asset strategy Thomas Thygesen said. “Timing is always important, but last year especially so. If you joined Europe’s rally from the onset, you did well, but if you came late to the party, you’ve probably gained very little.”
Meager gains may be good enough for last year, with the Standard & Poor’s 500 Index concluding the year down almost 1 percent for its first annual decline since 2011. And rallies exceeding 8 percent for benchmark indexes in France, Germany and Italy look downright impressive when compared with the 2.7 percent retreat in MSCI’s gauge of developed country stocks or the 17 percent plunge in its emerging markets gauge.
It is only compared with what might have been, that European equities — and the predictions of regional forecasters — disappoint.
The STOXX 600 surged 16 percent from January through March — the best quarterly return since 2009 — as the European Central Bank (ECB) flooded the financial system with cash by purchasing bonds.
The index then spent most of the first six months sitting on gains of 15 percent or more.
Progress sputtered in the second half, with the index falling 75 points from its April high to a low of 339.23 amid concerns that the region’s recovery would be interrupted by crises in Greece and China and the US Federal Reserve’s first rate hike in almost a decade.
Along the way came volatility. Since April, the size of daily moves in the STOXX 600 has widened by more than 40 percent, averaging 1 percent a day on a closing basis. Although European shares were comparatively stable, while the S&P 500 plunged 11 percent from Aug. 17 to Aug. 25, their peak-to-trough swing of 18 percent from April to September compares with a 11 percent lurch in US equities.
The upside of the swoon is that valuations for the STOXX 600 have returned to February levels, before the ECB began buying government bonds. As a result, European stocks are trading at a discount of more than 9 percent to their US peers, at 16 times projected earnings.
The STOXX 600 fell 5 percent last month, second only to a 9.3 percent drop in 2002 as the worst December on record.
Still, investors are preparing for a rebound, putting money into European equity funds in each of the past 12 weeks, according to a Bank of America Corp Dec. 29 note that cited EPFR Global data.
Strategists agree, saying that Europe’s benchmark will top last year’s record high this year. They predict that the STOXX 600 will rally 13 percent through the end of this year, or almost double the gains projected for the S&P 500.
One of the threats to progress this year is that the performance of stocks is predicated primarily on corporate earnings growth, and forecasts for European profits have been coming down faster than in the US, according to Saxo Bank A/S’ Teis Knuthsen.
In September, analysts projected European earnings growth would outpace US expansion this year. That view has now been revised, with analysts predicting an increase of 5.7 percent for STOXX 600 earnings, compared with 7.1 percent for members of the S&P 500.
“Europe can’t continue to outperform without significantly better profits,” said Knuthsen, chief investment officer at Saxo Bank’s private-banking unit in Hellerup, Denmark. “It’s been pretty disappointing in 2015 even with the cheap euro, lower oil prices, a domestic economy that’s turning and an extremely expansive monetary policy.”
For others, Europe’s resilience in the face of global growth concerns last year suggests that years of disappointing earnings are coming to an end. With the region’s economy at a tipping point, corporate profits may follow to push equity prices higher at a time when the US bull market is slowing down. The low euro will also continue to be a boost for both countries and companies that depend on demand from overseas.
“The European recovery is definitely in for some reacceleration,” Danske Bank A/S chief analyst Allan von Mehren said. “We’ve had waves of disappointments, but now 2016 is looking pretty good, and corporate profits stand to benefit. Europe has been through so many up and down cycles, but it’s really catching up with the US now. It’s a good time for equities.”
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