A spike in bond yields this year might have spooked many global equity investors, but fans of the historically underperforming European market are winning big.
The blue-chip Euro STOXX 50 has surged 11 percent this year, outpacing other major market benchmarks including the S&P 500 Index and the NASDAQ Composite Index.
A predominance of cheap and cyclical shares has turned from bane to boon for Europe as fund managers focus on the recovery from the COVID-19 pandemic and fret over frothy valuations.
The benchmark STOXX 600 on Thursday rose 0.6 percent to 432.22, up 1.24 percent weekly. European markets were closed on Friday for the Good Friday holiday.
The likes of JPMorgan Chase & Co and Amundi SA, the region’s biggest asset manager, have said that European stocks can outperform the US this year, despite concerns over a slow COVID-19 vaccination pace and lockdowns in major economies like France and Italy.
Even as it flirts with a record high, the STOXX 600 trades at a discount of about 21 percent to the S&P 500 on the basis of its 12-month forward earnings.
“Europe is indeed well-positioned to benefit from an environment of economic growth accelerating and rising rates,” said Kasper Elmgreen, head of equities at Amundi, which oversees about 1.4 trillion euros (US$1.65 trillion) in assets. “I expect European outperformance to continue.”
Value and cyclical sectors rallied strongly in the first quarter of this year, with the STOXX 600 gauges for autos, lenders, and travel and leisure up about 20 percent.
Europe not only benefits from its discount valuations and the strong presence of banking stocks, but also from being one of the least crowded equity regions globally, JPMorgan strategists have said.
The STOXX 600 has lagged the S&P 500 in all but two years of the past decade.
“We believe that this year the US will not be an outright regional leader. In fact, we think eurozone should outperform the US,” the strategists led by Mislav Matejka said in a note. “The valuation case remains appealing.”
JPMorgan is overweight on banks, saying it is the sector that is most positively correlated to rising bond yields and an economic recovery.
Financials have the heaviest weighting in the STOXX 600 among industry groups, comprising about 16 percent of the benchmark, compared with about 11 percent for the S&P 500.
Investors have been putting their money where their mouths are, with allocation to eurozone equities increasing to a net 30 percent overweight last month, a Bank of America Corp survey showed, the highest reading since August last year.
By comparison, US stocks had a net 9 percent overweight.
Historical trends are also supportive of further gains for Europe. The STOXX 600 tends to post bigger returns in April than in any other month, looking at the average over the past 25 years.
To be sure, Europe’s rally this year faces some risks beyond the vaccine and virus woes.
Bank of America expects stock gains to start fading after the macroeconomic cycle peaks in the third quarter.
Mike Bell, a global market strategist at JPMorgan Asset Management, sees European bond yields rising less than in the US, which is why he prefers American value shares.
“I’m frankly a bit surprised that European stocks have done so well,” Bell said in a telephone interview. “It’s more of a catch-up trade rather than a rotation.”
For the rally to continue, European companies need to deliver profit growth, Newton Investment Management global equities portfolio manager Paul Markham said.
There is good reason to believe that can happen after a record number of companies beat earnings expectations in the fourth quarter.
Plus, the bungled vaccine rollout is likely just a temporary setback for the region, BlackRock Investment Institute global chief investment strategist Wei Li said.
Once shots are more widely available in Europe, investors can count on accelerated growth through next year, she said.
“I expect a very meaningful economic and earnings recovery,” Elmgreen said. “There is significant pent-up demand at a time when monetary and fiscal policy is very supportive.”
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