European equities finding some takers

July 11, 2012

European equities are getting some investor interest again.

As the ongoing debt crisis erodes consumer spending and corporate profits, the euro zone’s share  in investors’ equity portfolios has fallen in the past year –Reuters polls show holdings of euro zone stocks at 25 percent versus over 36 percent a year back.  Cash has fled instead to U.S. stocks, opening up a record valuation gap between the European and U.S. shares. (see graphics below from my colleague Scott Barber). In fact no other region has ever been considered as cheap as the euro zone is now,  a monthly survey by Bank of America/Merrill Lynch found in June.

That could offer investors a powerful incentive to return, especially as there are signs of serious efforts to tackle the crisis by deploying the euro zone’s rescue fund.

Pioneer Investments has moved to an overweight position on European stocks. While Pioneer’s head of global asset allocation research Monica Defend stresses the overweight is a small one compared to, say, its position in emerging markets, she says:

We are now more positive on Europe than we have been for a long time before.  From mid-June after the election in Greece and the EU summit we have become more constructive on European equities and now favour European equities to the U.S market…

Defend notes that European equities now boast average dividend yields of 4-5 percent, rising to 6-7 percent for high cash-flow generating firms — higher than other developed markets. She adds:

Very slowly, all the politicians have become conscious of the need for the euro crisis to be resolved. The reason we were sceptical before was not equity market fundamentals but the macro economics and the risks stemming from the euro crisis.

JP Morgan Asset Management also recently lifted European equities to overweight, citing valuations. The fund’s David Shairp cites Goldman Sachs research showing that European equity valuations are implying long-term earnings growth of minus 6.3 percent a year for the next 20 years. He told clients in a note:

This writer is not optimistic about the resolution of the euro zone’s problems but he is not that bearish on the outlook for a corporate sector that boasts some world class companies, which have the option of trading outside their home region.

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