Continuing our countdown to Christmas, Rory Bateman discusses near-term risks facing European equity investors and assesses the longer-term outlook for earnings and valuations.
While we are encouraged by the European equity market recovery since the UK's EU referendum, the total return for the market is still down 4% in euro terms this year at the time of writing.*
European corporate earnings have fallen short
Once again, the key driver has been disappointing earnings relative to expectations, particularly in financials and energy. Earnings have been downgraded from +10% in January and we expect will finish the year at -4%, therefore we have actually seen a modest re-rating of the market so far this year.
If we strip out energy and financials the picture is better with earnings growth this year at around +5% which may be significant as we look forward to the next 12 months. Interest rates cannot go much lower, which should provide some support for the banking sector's profitability and the year-on-year comparisons for the oil price will begin to ease as we go into 2017.
Long-term European recovery?
This of course pre-supposes that underlying earnings in non-financials and energy can hold up or improve going forward which, given the low inflationary environment we are in, is a big assumption. We continue to believe, however, the European economic recovery is on track, albeit still sluggish, and the Brexit impact will be minimal.
Looking more internationally, the US appears robust and emerging markets are improving - although not universally - which should provide reasonable export markets for many European companies.
Italian referendum poses a risk
Italian prime minister Matteo Renzi is preparing to gamble his career and Europe's political stability on a divisive referendum to be held this weekend. Renzi is attempting to cut the Senate's powers to vote on laws and leave almost all legislation to the lower house - a change the prime minister claims will speed up the passing of laws Italy needs to reform its rigid economy and legal system.
Renzi may, however, come to regret his initial promise to step down if he fails to win the referendum - indeed, he now seems to be backtracking. This statement has prompted opposition parties to campaign not on the issue at hand, but to take advantage of the opportunity to get rid of Renzi. Indeed, recent polls suggest more than half of those likely to vote are voting on his future, and not on the merit of the constitutional reforms.
As the following table shows, other elections also pose risks. Donald Trump's track record of supporting anti-establishment issues and candidates, such as Brexit and Russian President Putin, could legitimise Eurosceptic groups.
Political events in Europe
|Country||Event risk||Date||Probability||Market impact|
|Austria||Re-run of presidential election with far-right Freedom party winning||4 December 2016||Medium||Low|
|Italy||Constitutional referendum, leading to Renzi losing his job||4 December 2016||Medium||High|
|Netherlands||General election with the Party for Fredom calling an EU referendum||15 March 2017||High||Medium|
|France||Presidential elections with the National Front winning||23 April & 7 May 2017||Low||Extreme|
|Germany||Federal election with Alternative for Deutschland winning||August-October 2017||Very low||Extreme|
|UK||Article 50 triggered||Early 2017||High||Low|
With the EU questioning its post-Brexit future, empowered fringe parties could potentially redefine the geopolitical landscape . Elections in France and Germany in 2017 should be more straightforward, but Brexit has taught us not to underestimate protest movements.
Rory Bateman, is head of UK and European equities at Schroders. For the full report or to read more views from Schroders' experts, please click here
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Important information: *4 November 2016.The views and opinions contained herein are those of Rory Bateman and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Schroders has expressed its own views and opinions in this document and these may change. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Issued in June 2016 by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority. UK11332
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