OLLY RUSS, manager of the Ignis Argonaut European Income fund on Europe
The market’s positive reaction to the European bank stress tests and the stabilisation in sovereign debt markets could point to a sustainable recovery in European equities.
A recent Spanish debt auction was well-subscribed, and the Greek Government has reported its austerity package seems to be working, with the deficit reduction apparently ahead of schedule and the IMF and ECB satisfied with progress so far.
The ECB has stopped its emergency purchases of peripheral sovereign debt, and the market in these securities seems to have returned to some degree of normality.Corporate earnings have also proved supportive. According to Deutsche Bank, 73% of European companies have exceeded sales expectations, with 62% seeing this feed through to the bottom line to bear earnings expectations.
This is the strongest revenue line beat since Q1 2006, and comprehensively answers the critics who regarded strong earnings as nothing more than cost-cutting and margin stories – at best undeserving of a multiple, at worst detrimental to overall economic growth.
We expect strong earnings releases will continue into the autumn, particularly from exporters in the industrial and autos sectors, as well further good numbers from the telecoms and media sectors.
Markets look well supported at these levels, given a favourable economic backdrop in core Europe, and particular strength in the export-led German economy.
German unemployment is now at 7.6%, lower even than the boom times of 2007. This is due partly to a reform of the benefits system and partly to do with a resurgence in manufacturing.
However, outside Europe, persistently weak US employment data remains a concern, as does the state of local and central government finances. We remain sceptical of the media’s obsession with a double-dip recession. For the time being, the path of least resistance seems to remain economic expansion.
Markets have had a strong run since their May lows, up around 15% from those levels. Even so, valuations remain depressed when compared to historical trends. A recent Barcap study highlighted how European equities are now trading at a 36% discount to 27-year average on cyclically adjusted P/E ratios – a level historically associated with 40% one-year total return.
The Equity Risk Premium is well above the 20-year average, at 8% versus 4.5% average, and dividend yields are at a 21% premium to 12-year average. Unless Western markets are entering a state of terminal decline, European equities in particular are exhibiting attractive valuations and compelling fundamentals.
Olly Russ is manager of the Ignis Argonaut European Income fund
