Energizing Europe: Regional Markets Show Signs of Recovery

European stocks have outperformed US equity markets in recent months, after several years of underperformance. Is this the start of a longer trend? It’s too soon to say, but some unfolding developments could signal a reversal of fortune for a long-unloved asset class.

The MSCI Europe Index has gained 4.7% (in euro terms) from September 1 through October 31, versus the S&P 500 Index’s 4.0% (in US-dollar terms). So far, the outperformance has been modest, and it could quickly reverse. But macroeconomic signals, regional earnings drivers and even a potential easing of political risk may help stem a tide of outflows from European stocks, in our view.

Economic Outlook: Back from the Brink

Signs of improvement in the economic outlook could favor European stocks. Markets are currently pricing in a lot of bad economic news. But some commentators are detecting signs that the recent slowdown in economic growth could be bottoming. For example, services in general continue to look resilient. Given the amount of pessimism in markets, we believe that any upside surprises in economic data could support an accelerated equity rally.

To be sure, US company earnings still look better than their European peers, based on companies that had reported their third-quarter earnings through the end of October. And a higher percentage of US companies are beating consensus forecasts. But European-listed companies, especially outside the UK, on average have earnings that are more sensitive to the economic cycle than those of larger-capitalization names in the US. As a result, any lifting of the economic gloom will tend to benefit the European market more, in our view.

From a technical point of view, after massive outflows from European equities in recent years, many investors are heavily underweight Europe. So far in 2019, more than half the outflows from equities globally have been from European markets, even though European stocks account for only about one-fifth of the MSCI All Country World Index. If this trend reverses, we think it could potentially drive a powerful rally.