Three themes for European equities to be back in focus

• Volatility is here to stay. Markets are hostages of very volatile news flow. Trade-related anxiety is driving the swing (pessimism of a broken deal between China and US led to a correction in May while the renewed hope of a partial deal brought equity markets back to yearly highs in June). More recently, the ultra-dovish tone of major Central Banks added to the optimism, signalling the commitment to extend the current cycle, amid a deceleration of global growth and a not brilliant earnings outlook. Against this backdrop of uncertainty we expect global equities to remain in a trading range, pointing to the need for investors to focus more on relative value opportunities across regions and names to extract value rather than betting on strong directional calls.

• On a regional basis, we believe there is room for European equities to be among the outperformers in the global equity space and provide fertile ground for investors in search of opportunities. For global investors, having a bearish positioning on Europe, we think it is now time to reconsider the allocation to this asset class, especially on a relative basis on the back of three main themes.
• Theme 1. Europe could benefit from a stabilisation in the economic outlook, European Central Bank (ECB) accommodative stance and fading political risks. Moderate growth to continue, sustained by a decent domestic demand, even if risks are tilted to the downside, and they are strictly connected to the geopolitical situation (trade war evolution). The possibility for the ECB to further add stimulus is another supporting element, preventing an unwanted Euro currency appreciation and reinforcing the shield against a deterioration of the global economic picture.
• Theme 2. Converging earnings growth vs. the rest of the world and fair valuations make Europe more investable than the positioning of investors suggests. 
• Theme 3. With a medium to long-term view European equities also remain attractive for Euro based investors in search for yield and for investors with a focus on ESG themes.

Theme 1. Stabilisation in the economic oultook and fading political risks

Uncertainty persists with the trade war still making the headlines. Fresh positive news on the economic side is needed to support stock markets as the up-trend phase cannot last for longer without the macro support. Where is Europe going from here?

1. Stabilisation of growth outlook. Overall, economic surprises have recently become much less negative than at the beginning of 2019, despite persistent pressures on manufacturing sentiment indices. The growth outlook will remain positive, although not as strong as in Q1. Nonetheless we expect most other economic metrics to improve gradually due to different factors. First and foremost, cyclical variables (especially employment and wages) remain on a positive trend. Moreover, the fiscal stance in the four largest countries is easing (for an estimated total of 0.5% of Eurozone GDP). Gains in household real disposable income will be a very supportive factor in 2019, also helped by the recent decline in oil prices. Moreover, the ECB remains very dovish: further measures are expected to stabilise inflation expectations and attempt to reach the inflation target.
   On the other side, there are risks to monitor, especially linked to the prolonged weakness in global trade and manufacturing which could ultimately change the corporate attitude towards hiring. Also, a rise in households’ precautionary savings could erase the effect of the positive factors mentioned above. A no-deal Brexit and potential new US tariffs on European goods are also major risks to watch.
   However, all in all, we believe that the recent pessimism on European economy is overdone.
2. Reduction of political risks in Europe. In autumn there could be more visibility on the Brexit evolution, and the new equilibria following the European elections will slowly materialise. What came out from the elections was a still strong pro-European bloc, with a contained advancement of populist or euro-critical forces (mainly in Italy and in France) that, however, will contribute to keep the political factor in focus. Progress in the China – US deal could certainly help in creating a more favourable environment for stocks. We still see a limited consensus in the US for a tariff increase against Europe, and the already decelerating US economy could curb President Trump to move aggressively.

As the European equity market is highly linked to the global cycle (European companies derive more than half of their revenues from outside Europe), the view that EU equities could outperform in relative terms is based on the fact that our central scenario (deceleration of the US economy to its potential combined with some stimulating measures in China, no further escalation of the trade war and strong domestic demand) is confirmed. For European equities to outperform, it is important that the economic outlook improves vs the other G10. From the chart below, the relative EU market performance tends to move together with the economic surprise index differential, which recently has started to move in favour of Europe.