We were recently asked by a client what our outlook was for European equities in the 2018 calendar year. The short answer is that we are in the business of picking stocks, not aggregated regional indices. This answer, of course, is obviously not particularly helpful, so we also tried to draw some sensible conclusions from a number of key economic observations.
The first is that Eurozone economic growth has been accelerating in recent quarters, as shown below. While Europe was the global “problem child” in 2011 and 2012, it has since rebounded and is now demonstrating some real strength.
European GDP Growth (Percent Annualised)
While growth in the Eurozone has been led by the industrial sectors, there are positive indications that these gains will likely be transmitted to consumer industries. Shown in the chart below is annual wage growth. The red line relates to the growth in employee wages in Eurozone industrial and services firms. As is observed, these growth rates have never been stronger in the preceding quarter century.
Annual Wage Growth
A key driver of this recovery has been the emergency monetary policy settings that have been in place for at least the last five years. The European Central Bank’s key benchmark rate remains at zero and “non-standard” measures (i.e. quantitative easing) have been in place since March 2015.
European Central Bank Benchmark Interest Rate (Percent)
Based on the most recent public statements, these non-standard measures will run “until the end of September 2018, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim.” It was also noted that: (i) the policy interest rate will remain at 0% for a time horizon that is “well past the horizon of the net asset purchases”; and (ii) if the outlook becomes less favourable, these asset purchases could even be increased.
All of this tells us that the there is a high probability that over the course of calendar 2018, monetary conditions in the Eurozone will remain extraordinarily accommodative at a time during which growth is accelerating. These are typically highly attractive conditions for equities in general.
Finally, one must always consider the valuation of any asset that is being purchased. While the forward P/E ratio is a crude metric at best, it does perhaps tell us something about the relativities in valuation levels between large aggregated geographical markets.
As illustrated below, European equities are, in general, cheaper relative to their forward earnings estimates than: (i) the developed world in general (MSCI World); and the US (MSCI US).
Forward P/E Multiple Comparison
A warming economy that remains a long way from overheating; combined with highly-accommodative monetary conditions; combined with relatively cheap valuation multiples is an attractive combination for investors in general. And if European equities do well in 2018, Montaka investors stand to benefit: approximately half the Fund’s net market exposure is domiciled in the European region.
 (ECB) Monetary policy decisions, January 2018
Andrew Macken is Chief Investment Officer with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.