The Business Times

Draghi touch is golden for stocks as Europe gets US$11 billion

Published Tue, Mar 3, 2015 · 12:26 AM
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[LONDON] Why buy European stocks? For Kerry Craig, the answer is, why not?

Mr Craig, a global strategist at JPMorgan Asset Management in London, says European shares look like a bargain next to bonds. Corporate profits are picking up, while yields - already negative in some countries - can scarcely go lower. Plus, investors' worst fears about Greece and Ukraine have receded.

"A lot of the negative stuff that was supposed to blow up in the past month didn't," Mr Craig says. "We're getting to the point where even a bond guy will tell you to buy stocks." His view is ratified by what's known as the Fed model, a valuation metric that compares the equity market's earnings yield to the rate on government bonds. While the measure isn't unanimously embraced, if you use it, European stocks have never looked like a better buy. That's even after the Euro Stoxx 50 Index jumped 14 per cent in 2015, its best start to a year ever.

Estimated profits as a proportion of share prices in the Euro Stoxx 50 come out to 6.4 per cent, 11 times more than government-debt rates as measured by the Bloomberg Eurozone Sovereign Bond Index. The earnings yield reached a 16-month high of 7.9 per cent in January.

Investors poured US$11 billion into European share funds in the two weeks through Feb 25, including the biggest weekly inflow on record, while withdrawing US$315 million from government debt, according to a Bank of America Corp. report citing EPFR Global data. Fredrik Nerbrand, global head of asset allocation at HSBC Holdings, boosted his European-equity position in January and cut German bunds.

"That was partly because of valuations, but also because we're starting to see evidence of a turnaround in Europe," Mr Nerbrand said by phone from London. "You want to be an owner of European risk, especially after the pro-cyclical ECB move." After the US experiment with quantitative easing, the Standard & Poor's 500 Index more than tripled, reaching a record last week, and company earnings doubled. The prospects of increased stimulus from Mario Draghi's ECB spurred a 25 per cent rally in the Euro Stoxx 50 since October as bond yields across Germany, Finland, France and the Netherlands turned negative.

The Euro Stoxx 50 lost 0.2 per cent at the close on Monday.

Even with the index of European shares at an almost seven- year high, some equities look cheap. Deutsche Bank AG and Societe Generale SA have both jumped 18 per cent in 2015 while their valuations of around 10 times projected earnings are at least 9 percent away from their 2014 peaks. Following a 42 per cent rally in 2015, Renault SA's 9.4 multiple is still below the average for European carmakers.

"The game is going to be which company generates the best profits, because I want to be where the earnings growth will give me the biggest return," said William Hobbs, head of equity strategy at Barclays's wealth-management unit in London. "It's going to be a tricky time for fixed-income markets, and equities are still where your bread is best buttered." Speculation Draghi's policies will help improve economic growth as the euro weakens has helped boost bets corporate earnings will increase. Profit at Stoxx Europe 600 Index companies will rise 7.3 per cent this year, according to the average analyst estimate compiled by Bloomberg. That's more than triple the projected increase for S&P 500 members.

The Fed model for gauging relative value between stocks and bonds was derived by US economist Edward Yardeni from a July 1997 report by the central bank. Critics have contended the technique doesn't work because inflation affects stock valuations and interest rates differently.

"The Fed model misses all sorts of things," said Ros Price, the chief investment strategist at Seven Investment Management in London. "What if equities are wrong and bonds are right?" she said. "Company earnings won't be as exciting in a deflationary environment. Labor costs won't drop as fast, and profit margins will get squeezed." The bond market is starting to shrug off the threat of deflation. Pacific Investment Management, Natixis SA and Invesco are buying bonds that protect against rising prices.

Allocations among fund firms to European equities are at the highest level since May 2007, and 77 per cent of investors project stronger profit growth in the next year, according to a Bank of America Feb 17 fund-manager survey.

Analysts who raised earnings estimates for European companies exceeded those cutting them last month. With economic data topping forecasts by the most in almost two years, the risk of recession has dropped to 15 per cent from 20 per cent in January, according to a Bloomberg survey of economists.

"There's no alternative but to stick with stocks," said Luca Paolini, Pictet Asset Management's chief strategist in London. "Stocks are still the cheapest asset class you can find in Europe. With earnings improving, there's not much that can stop European equities from having a very decent year."


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