Strong upside potential for Eurozone equities!

Eurozone equities still offer an attractive expected return, even after the impressive return since the beginning of the year.

Both the equity and bond markets have realized strong performances over the last three years. The supportive monetary policy of the world’s central banks has pushed interest rates down and equity markets higher. Since the beginning of the year, investors have mainly benefited from the rally of the equity markets, despite the uncertainties regarding Greece and the tensions between Russia and Ukraine. The Eurozone especially was the place to be, supported by both the start of the ECB’s quantitative easing programme and a significant improvement in the region’s economic prospects.

Growth and liquidity

The Eurozone economy has finally turned the corner. For Q4 2014, economic growth had increased by 0.9% YoY, and is now further accelerating. Budgetary tightening will be more limited this year than in previous years. Meanwhile, economic growth is being supported (a) by the gradual recovery in consumer spending following the oil price drop, which should boost households’ purchasing power by around 0.6% of GDP, and (b) by the euro depreciation, which has clearly boosted exports outside the Eurozone. In that context, we have increased our growth expectations for the region to 1.6% for 2015 and to 2.0% for 2016. Moreover, while the Eurozone economy is progressively returning to normal, the European Central Bank is continuing its accommodating monetary policy.

Eurozone catch-up bound to continue

Despite their strong performance in recent months, Eurozone equities still aspire to further upside potential. The combination of accelerating economic growth and increasing liquidity is clearly supportive to equities, whose valuation relative to bonds (where yields are close to historically low levels) still looks appealing.

The Eurozone equity market is benefiting from stronger economic momentum than the US and a greater recovery potential in corporate earnings. The impact of the economic recovery on earnings will be significant. Real economic growth of between 1% and 2% has had a positive impact of more than 10% on earnings forecasts, while the depreciation of the euro is also a welcome bonus for Eurozone corporate earnings.

A good start often results in a good year (1988 – 2015)
Will Eurozone equities be able to consolidate their strong start to the year over the course of 2015? A Candriam study shows that a strong start in the first two months of the year (of more than 10%) often results in an even stronger performance for the whole calendar year. This has almost always been the case, with the exception of 1991 and 1992, when the Japanese real estate bubble burst, India risked a default on external bonds and Europe faced a currency crisis after a recession. Nevertheless, even in those years, calendar-year performance was still positive.