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A bullish case suddenly builds for unloved European assets
WHEREVER you look, European markets are showing signs of emerging from the long shadows of Italian political risk and trade wars.
Laggards in this year's global stock rally, European equities have seldom looked so cheap in seven years - and unusually, they're now climbing at the same time as the euro strengthens.
Amid the second-busiest week of the year for new issuance, credit spreads are nonetheless tightening, while the yield gap between Germany and the region's periphery is also starting to narrow.
No wonder Mario Draghi, the European Central Bank President, joined central bankers from the UK to Sweden to the Czech Republic in sounding more upbeat as he discussed the economy with policy makers in Brussels this week. Reasons for cheer include faster inflation and the promise of sustained growth, Italian populists toning down animosity toward the European Union, and the US government keeping its trade focus on China. "The tide is turning," said Momtchil Pojarliev, deputy head of the currencies team at BNP Paribas Asset Management, which oversees US$653 billion. "Looking forward, we are going to see convergence of monetary policy."
Investors are betting the ECB will hike rates in October 2019 for the first time since 2011. At around the same time, the Federal Reserve is expected to pause in its tightening path.
The ECB is pushing ahead with its plan to end asset purchases this year as euro-area inflation converges toward its goal. Mr Draghi has highlighted a "relatively vigorous" pickup in underlying price pressures, and the central bank says interest rates won't rise until after the summer of next year. Norway and the Czech Republic are already tightening, with the krone climbing 3.3 per cent against the dollar this month, and the koruna up 2.2 per cent.
"As we look forward through next year, we think the differences will narrow quite a lot," Goldman Sachs Group Inc's chief global equity strategist Peter Oppenheimer said in an interview with Bloomberg TV. "There won't be such big differences between the US and other global markets, in contrast to what we've seen over the last few years." European stock funds that have been hit by redemptions for 27 of the past 28 weeks may be set to benefit from the turning tide, according to Barclays Plc strategists.
In a note to clients, a team led by Emmanuel Cau said "relative equity flows of US versus Europe look extreme in a historical context and could reverse in the near term". Bearing the cheapest valuations in seven years based on their price-to-earnings ratio, European equities look tempting to Amundi Asset Management and Societe Generale SA, especially compared with pricey US peers.
"We favour European stocks over the US with a focus on value, and we think there's been some capitulation priced-in already," said Sophie Huynh, a cross asset strategist at Societe Generale in London.
Investors have started betting on the victims of US President Donald Trump's trade threats.
Automakers, among the worst-performing sectors in Europe this year, turned higher in the last two weeks, rising nine out of 10 sessions through Friday. Luxury brand Porsche AG and mass producer Volkswagen AG both rallied more than 13 per cent over that period, as Trump enacted sanctions against China, while taking no new steps against producers in the single market.
European bank stocks, down 12 per cent so far this year, are expected to be among beneficiaries from higher interest rates.
Meanwhile in credit markets, 30 billion euros (S$47.5 billion) of investment-grade corporate supply since the start of the month has been swallowed without a hiccup. Borrowing costs have actually fallen, with the average spread for euro credit at 113 basis points from 120 basis points at the start of the month, according to Bloomberg Barclays index data.
Still, policy makers have stressed the downside risks, such as the ripple effects from a trade war between the US and China. Emerging-market turbulence and the risk of a messy exit of the UK from the EU are adding to uncertainty.
In Italy, at least, the ruling coalition of populists have softened anti-EU rhetoric with assurances to stay in the single market and hew to its fiscal targets. The country's budget, out on Sept 27, will be closely watched to see how this is balanced against higher spending. After spiking as the populists came to power, the spread between Italian benchmark bonds and German bunds has narrowed this month. BLOOMBERG