European shares come in from the cold

Investors have learnt to stop worrying and love European equities. 

Already, and with little fanfare, the continent’s stocks have been on a tear. The Stoxx 600 index is up by 14.4 per cent so far in 2021, now more than a full percentage point ahead of the US’s tech-heavy Nasdaq Composite and not far behind the S&P 500. 

Granted, the European benchmark’s performance dims in dollar terms, to just under 11 per cent. Still, just around the half way point of 2021, this would already rank among the index’s best full years in a decade.

Typically, the accepted wisdom on Europe is that US investors ignore it. The sovereign debt crisis, which peaked with a restructuring of Greek government bonds in 2012 and which came close to felling key parts of the continent’s banking system, lingered long in investors’ memory and helped to deter them for years. 

Euro-area equity bulls have long claimed to be exasperated at the lack of buy-in from the other side of the Atlantic.

Analysis from Goldman Sachs, however, suggests this supposed US reticence has been vastly overstated. “Europe’s problem has not been a lack of foreign buyers,” the bank said. “When there is growth and a lack of crisis, there tends to be a foreign bid for Europe equity; the problem is a lack of domestic capital allocated to shares.” 

A relatively modest 10 to 15 per cent of households’ financial assets are in equities, the bank calculated, compared with more than a quarter in the US. Even Europe’s own institutional investors have been reluctant to get in, preferring, in part for regulatory reasons, to park in bonds.

But local investors have started to buy, while US and Asian counterparts have also bulked up, Goldman Sachs said. Multi-asset investors and hedge funds — more influential forces on equity valuations — also stick out, drawn in by the relative allure of European stocks at a time when yields elsewhere remain skinny.

Now it appears to be hard to find any investor to bet on a reversal. In its latest monthly European fund manager survey, Bank of America Securities found that precisely zero respondents expected to see a decline in European equities in to the end of the year. A small band of doubters in the previous month had melted away.

More than 80 per cent expected single-digit percentage point gains, and for almost half of respondents, the most pressing risk was cutting equity exposure too soon, not failing to hedge sufficiently against a pullback. “A net 45 per cent of global investors say they are overweight European equities, the highest since January 2018,” the bank added.

Royal London Asset Management is one of them. “Our models really like the earnings revisions in Europe,” says Trevor Greetham, head of multi-asset. Refinitiv I/B/E/S data show second-quarter earnings are expected to more than double from the same period last year.

“Countries that got whacked hardest by Covid last year have been climbing out of the hole. First it was China, then the US and UK, and now it’s Europe,” Greetham says.

The latest policy tweak from the European Central Bank will likely help to give this relationship a little more staying power.

Earlier this month, the ECB announced that it would change its inflation target from “close to but below 2 per cent” to “2 per cent”, with a greater tolerance for moves above that point. To anyone outside of monetary policy or markets circles, that is underwhelming. For the ECB, however, as my colleague Martin Arnold succinctly put it, it is a break with “the conservative monetary doctrine of Germany’s Bundesbank that formed the bedrock of the euro’s creation”.

All things being equal, it suggests the ECB will be happy to see higher inflation, and will be willing to keep interest rates low even if inflation accelerates. Now, I would also be willing to be four inches taller and win the lottery. This does not mean either of those things will happen.

None of this means that long-dormant inflation in the eurozone will sustainably pick up, although it is more likely in the bounceback from the pandemic than it was earlier, and an additional move to loop housing costs in to the inflation measure may help.

In addition, the ECB tweak forms a clear contrast with the US Federal Reserve, which has fixed half an eye on the exit out of super-stimulative crisis-era policy. 

“There’s going to be a big fracture between the two most important central banks in the world,” says Gregory Perdon, co-chief investment officer at Arbuthnot Latham, a UK private bank. “There’s no way the ECB will come anywhere near the Fed in raising policy rates,” he adds.

This should help to keep the euro pinned lower, offering some gentle extra assistance to the continent’s exporters. 

True, an unanticipated early rate rise from the Fed — a tiny possibility — would be a global market shock. A little extra latitude from the ECB would be unlikely to cushion the blow. But for now at least, investors are clearly betting on a warm summer for European markets.

kate.martin@ft.com