Greece’s Ebb & Flow Has Not Destroyed the European Equity Rally…
While the second quarter has been generous with surprises and market volatility, European equities have staged a pleasant comeback following the outcome of the negotiations with members of the eurozone and the broader European Union on 13 July. Much of the reform package still remains to be approved by the Greek Parliament but the crisis mood has abated, allowing investors to turn back to the broader macro picture and try to focus on longer-term expectations.
Weaker purchasing managers’ index (PMI) numbers today, with the Markit PMI Composite Index estimates falling from 54.3 in June to 53.7 in July, do not necessarily imply that the growth outlook is worsening. Grexit risk has also weighed on sentiment, with the European Commission’s measure of confidence at -7.1 for July versus -5.6 in June.
Despite these disappointing numbers, GDP growth is still on track to be above 1%, according to economists. What’s more, a number of tailwinds remain in place for the European market as the ECB’s quantitative easing programme continues, with the potential to extend its list of QE assets beyond government and government-related bonds to corporate bonds. This environment is also expected to improve lending conditions for SMEs. Meanwhile, the US Federal Reserve’s first rate hike of this cycle is still in the pipeline, with the odds favouring a September lift-off, which could further weaken the euro.
Investors seeking to benefit from this further potential upside in European equities should consider utilising ETFs such the SPDR MSCI Europe UCITS ETF and the SPDR MSCI EMU UCITS ETF. From a sector standpoint, European Financials and Healthcare remain particularly attractive in this ECB-supported environment.
– ECB versus US Fed: the ECB is continuing its asset purchasing programme and has mentioned it would resort to further intervention if necessary. While talks of potential tapering were floated in May, they were rapidly dismissed and we believe the ECB will stick to its programme to try to support the eurozone economies. This should help corporations that stand to benefit from a lower-interest-rate environment, and should improve lending conditions for SMEs. It could also trigger increased M&A activity in Europe.
On the other hand, despite being unusually late in increasing rates in the expansionary cycle, the Fed may have to start normalising rates as soon as September. The Federal Open Market Committee minutes released earlier this month implied a move in that direction, but the hiking process will be gradual.
– A weaker euro should help exporters. Since the beginning of the year, a weakening euro has generally been positive for European equity indices, while equity indices have tended to retrench when the euro strengthens, as witnessed in May. June’s negative equity market performance is can be attributed to Grexit risk, but the currency trend has clearly influenced performance over the longer run.
– Earnings improvement
The turn in earnings momentum, driven by cyclicals, has broken the long streak of downgrades that has plagued European equities in recent years. Starting from a very depressed level, there is certainly more headroom for earnings growth to improve, driving the earnings part of the price-to-earnings ratio to support valuations. Over the last few years, markets have been re-rating with generally no earnings growth, leading investors to question whether valuations were becoming too stretched.
The second-quarter earnings season is underway and, despite a sense of caution among analysts, some earnings may surprise on the upside as in the first quarter of this year, which would further boost the case for European equities.
Flows Have Re-accelerated Since Mid-June
Flows in European equities remain strong year to date, with more than US$57 billion inflows into these indexes globally as of 23 July (Source: State Street Global Advisors, Bloomberg).
Flows into European equity EMEA-listed ETFs have been strong too, with around US$22.5 billion inflows, primarily in broad-blended indices (US$17.5 billion). Country funds gathered more than US$2.6 billion US$ but experienced wide moves in DAX indexations around April/May. Since mid-June, investors have been buying on dips, supporting the strong flow trend.
Investing in European Equities with SPDR ETFs
The turnaround in earnings momentum, combined with encouraging flow trends and macro tailwinds, should provide favourable conditions for European equity markets.
SPDR ETFs are designed to enable investors to accurately articulate their strategic and tactical allocation views. Our European Equity range provides exposure to the broad MSCI Europe and MSCI EMU indices (see table below for details) while our range of MSCI Europe Sector ETFs, for example the SPDR MSCI Europe Financials ETF outlined below, enables investors to implement specific sector views.