U.S. investors are taking notice of European stocks, and they like what they see.
The victory by centrist Emmanuel Macron in France’s presidential election May 7, easily dispatching far-right euroskeptic Marine Le Pen, reassured many that the tide of antiestablishment sentiment sweeping across the U.K. and the U.S. last year has ebbed—at least for now. Indeed, many investors appeared to have come to that conclusion well before the votes were cast in France.
Improving earnings combined with subdued political risks saw European equities enjoy their largest weekly inflow on record last week, noted analysts at Bank of America Merrill Lynch, citing EPFR data.
Scott Clemons, chief investment strategist at Brown Brothers Harriman, is taking an incremental approach, having “dialed up” client exposure to Europe since last summer.
The European economy seems to have finally found its footing, he said, in a phone interview. “If there’s a little hesitation in my voice, it’s because it seemed to have found a footing several times over the past six or seven years,” only to retreat somewhat.
But at the margin, purchasing managers indexes look better and overall signs of economic activity continue to pick up, leaving Clemons confident in a turn for the better. Indeed, the Markit eurozone composite purchasing managers’ index hit a six-year high of 56.8 in April, marking the 46th consecutive month of expanding private-sector activity across the region. A PMI reading of 50 or above indicates healthy economic expansion.
And that is being reflected in corporate earnings, which are showing signs of life, the Brown Brothers Harriman strategist said.
European equities also remain cheap relative to the U.S., he notes, with U.S. companies trading at around 22 times trailing 12-month earnings versus 17 times for European companies.
U.S. stocks have been the primary driver of global equity market gains in the years since the financial crisis. Now, investors are increasingly scouring for equities outside the U.S. to provide leadership.
European stocks have already seen some outperformance in 2017, with the MSCI Europe ex-U.K. index is up around 15% in dollar terms year to date, versus a 6.9% rise for the MSCI U.S. index and a 7.3% rise for the S&P 500 SPX, +0.48% The pan-European Stoxx 600 index SXXP, -0.08% is up nearly 14%.
Those gains may make some analysts wary about chasing European stocks in the near term.
“In the short run, strengthening economic data and reduced political uncertainty look priced in,” said Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics, in a Friday note.
Indeed, there are risks to chasing European yield, analysts said.
While there is reason to be optimistic about eurozone stocks, the region’s recent outperformance leaves equities vulnerable to a near-term mean reversion, making him reluctant to “chase the [eurozone] equity market higher from here.”
Clemons acknowledged there was potential for a near-term setback, but said that long-term investors should view any such pullback as an opportunity.
On average, client equity portfolios stand around 60% U.S. and 40% international, he said. And around 15% of that international allocation is made up of European stocks, up from around 8% in the middle of last year.
“I think if we got a pause or a correction, we would use that as an opportunity to bump those numbers up a little,” he said.