Q4 2017 Portfolio Discussion: Investing in Europe - J.P. Morgan Asset Management

Q4 2017 Portfolio Discussion: Investing in Europe

After a long period of stagnation, company earnings now have plenty of room to rise as the economic recovery continues. We do not expect Brexit to lead to recession in Europe and, if political risks continue to subside, investors could start to focus more on the improving economic and corporate fundamentals.

The European economy is recovering, with recession risk low
  • Unemployment in Europe is falling, but given it is still high, there is still plenty of room for the jobless rate to fall further. The market cares more about the change in unemployment than the level of unemployment, so unemployment continuing to fall could well support both the economy and markets.
  • Retail sales and industrial production data are also recovering, showing that the recovery is broad based.
  • Business sentiment surveys are suggesting that growth should remain healthy.


17 Eurozone growth monitor

Guide to the Markets - UK, page 17

Room for recovery in European earnings
  • Companies had struggled to grow earnings since 2011, thanks to pressure from a second recession, followed by a strong euro and then the collapse in commodity prices.
  • Economic recovery should normally be expected to lead to an improvement in earnings growth. For years, earnings expectations for Europe have started the year high and then been downgraded throughout the year. This year, earnings expectations have not been revised down.
  • It is not only expectations that are improving - actual delivered earnings are growing too and the growth is broad based across most sectors.


38 MSCI Europe ex-UK performance and drivers

Guide to the Markets - UK, page 38

The end of European equity underperformance?
  • Earnings growth really matters for the performance of European equities. A stronger euro does not mean that European earnings cannot grow strongly, as shown by the period prior to the 2008 financial crisis.
  • Margins in Europe are depressed but are starting to rise as stronger nominal growth boosts sales and operating leverage amplifies that into even stronger earnings growth. As European margins are coming off of a low base they should be able to rise further.
  • Some investors fear they are too late to the party in European equities after a strong start to the year, but flow data suggests that not all of the money that came out of European equities last year is yet to return.


37 European equities

Guide to the Markets - UK, page 37

Investment implications
  • European equities could benefit from continued economic recovery feeding through into corporate earnings growth.
  • The European Central Bank noted recently that “political winds are becoming tailwinds.” If concerns around Italy prove to be overdone, as they did in France, this could provide a boost for European equities given the improving economic backdrop.
  • A stronger euro does not prevent European companies earnings from growing.

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