Markets & Economy

International Equity

Increasing Opportunities in European Equities

August 21, 2018
Increasing market and sector volatility are resulting in more attractive valuations for select higher-quality European companies.

Key Points

  • 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.

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.

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.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of August 2018 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance cannot guarantee future results. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.

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