PRICE POINT - IN BRIEF

Increasing Opportunities in European Equities

Dean Tenerelli , Portfolio Manager

Key Points

  • Increasing market and sector volatility are resulting in more attractive valuations for select higher-quality companies—in the context of a broader market where valuations are capable of being supported by sustained earnings growth.
  • Economic fundamentals continue to develop positively in most European countries, although the degree of momentum and global synchronization has lessened since earlier in the year.
  • Decent earnings growth is likely this year and next, but European political upheaval and external uncertainties could create headwinds.
  • Our disciplined focus on higher-quality companies trading at a discount has led us to some defensive areas that seem out of favor with investors.

European Stock Valuations Are Attractive; Upside Potential Depends on Earnings

Increasing market and sector volatility are resulting in more attractive valuations for select higher-quality companies—in the context of a broader market where valuations are capable of being supported by sustained earnings growth. Second-quarter earnings thus far have been encouraging, but first-quarter European earnings were weaker than in the U.S. and Japan. Although many asset classes appear to be fully valued, equities in developed European markets—following the stock market decline earlier this year, which presented us with some attractive, high-quality investment opportunities—were trading at just over 18 times the cyclically adjusted price/earnings ratio (i.e., the Shiller P/E), which is below their longer-term historical average. Our focus on higher-quality companies that trade at a discount but have superior and sustainable return potential has led us to some defensive areas that seem out of favor with investors. Earlier this year, we added to holdings in the industrials and business services, financials, and health care sectors. More recently, we have been finding some selective opportunities in cyclical industries where we believe the market is unfairly penalizing companies.

 

Expansion Supports Earnings, Should Counter Monetary Tightening and Stronger Euro

Economic fundamentals continue to develop positively in most European countries, although the degree of momentum and global synchronization has lessened since earlier in the year. The eurozone economy is still expanding, although it has been slowing recently, and strengthening in the manufacturing and services sectors is broad-based. In our opinion, these factors should help corporate earnings growth, particularly because we expect that the European Central Bank (ECB) will continue its accommodative policies. The ECB recently decided to cut its monthly bond purchases in half (from €30 billion to €15 billion) after September and to stop purchases completely at the end of 2018. The ECB also said that it would keep rates on hold until “at least through the summer of 2019.”

 

Political Uncertainty and Tariffs are Risks

While we expect decent earnings growth in the coming year, political risks could create headwinds to the economic expansion. Among the most significant risks are the populist coalition government in Italy, the fragile new Socialist-led government in Spain, and the contentious Brexit process, which must be completed by early 2019. In addition, the Trump administration’s trade tariffs on imports from European partners and China could weigh on global economic growth. Downside risks to growth in trade-driven Asian economies, major markets for many European exporters, are a legitimate concern.

The outlook for European earnings growth remains positive, underpinned by the continuing domestic economic expansion, solid fundamentals, and synchronized growth in most parts of the world.

201808-571752

IMPORTANT INFORMATION

This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.  

It is not intended for distribution to retail investors in any jurisdiction.