18th June 2013
Investors have the potential to gain strong returns from European equities J.P. Morgan Asset Management is arguing.
In Market Insights: The opportunities in European equities, it argues that strong returns are possible if the MSCI Europe Index regains its pre-crisis peak in coming years.
The fund manager suggests that in promising to do “whatever it takes” to stabilise the eurozone and delivering such remedies as the Securities Markets Programme (SMP), long-term refinancing operations (LTRO) and Outright Monetary Transactions (OMT), European Central Bank president Mario Draghi has made it clear he stands ready to ensure the future of the EMU.
Kerry Craig, Global Market Strategist, J.P. Morgan Asset Management, says: “This creates a powerful psychological backdrop for equity investors. Merely the existence of the OMT has materially compressed peripheral sovereign bond yields, indicating that a large amount of the tail risk of a eurozone collapse has been removed. At the same time the eurozone is going through a very necessary rebalancing as the structural reforms needed to improve competiveness in peripheral economies gradually accelerate.”
JP Morgan also says the high tide of austerity has passed, with even UK Chancellor George Osborne promising “flexibility” in his deficit reduction plans to encourage economic growth.
It adds that it is probable that German Chancellor Angela Merkel, who has favoured the implementation of austerity throughout the crisis, may begin to embrace more pro-growth policies. For example, during the recent trip to Germany by Italy’s newly elected Prime Minister, Enrico Letta, Merkel noted that “budget consolidation and growth need not be contradictory.”
Long-term potential in European equities
With crisis containment and improving fundamentals, J.P. Morgan says investors could begin bidding up equity prices as appetite for risk returns. The following chart illustrates the return investors would achieve, mathematically, if the MSCI Europe Index were to regain its pre-crisis peak in the next five years.
Daniel Morris, Global Market Strategist, J.P. Morgan Asset Management, says: “Even if it takes markets until 2018 – a full decade after the onset of the crisis – investors getting back into the markets now stand to achieve nearly double-digit annualised total returns.”
He argues that correlations between large cap stocks globally have declined, creating opportunities for stock pickers as equity correlations tend to spike during crisis periods when investors don’t differentiate between good and bad companies. As a crisis recedes, the importance of stock selection returns and creates opportunities for investors.
Darkest before the dawn
History shows that the strongest equity returns follow the most extreme troughs in sentiment says J.P. Morgan. On average, markets surged by double digits in the year following historic lows in confidence, while returns were much weaker when investors bought with confidence. This is not meant to suggest that investors should try to time the lows in sentiment, the paper says. However, low levels of consumer confidence may keep investors away from markets, but history shows this could be a mistake.
What is the opportunity for European equity investors?
As the fear of an EMU breakup subsides and Europe continues to make progress with structural reforms, the fund manager argues that long-term investors stand to benefit from a European equity market that offers attractively priced opportunities underpinned by low core government bond yields, corporate earnings growth opportunities from exports and an eventual recovery in confidence at home.
Andrew Goldberg, Global Market Strategist, J.P. Morgan Asset Management says: “The market recovery in Europe will not be smooth or without setbacks, and investors should remain well diversified to cushion the bumpy ride. But the inevitable flare-ups and anxiety-inducing headlines about austerity and the future of the euro should not distract long-term investors from the attractive fundamentals and less uncertain backdrop, as times of great pessimism have historically presented some of the greatest investment opportunities.”