European equities are “a good bet”, says Edward Perkin of Goldman Sachs Asset Management. He’s putting his money where his mouth is, as David Oakley points out in the FT. Pension funds and other major American investors ploughed $65bn into European equities in the first half of 2013, the highest sum in 36 years for the January-to-June period.
Why? Because they’re cheap and the earnings outlook is improving as the continent’s economy very gradually recovers from a long recession. Profits have some catching up to do. In America, they reached a new high in 2011. But in Europe progress was interrupted due to the debt crisis: profits are still 10% below their ten-year moving average.
However, according to Karen Olney of UBS, profit growth of 8% a year over the next three years – not “a big ask” – would return corporate Europe to the 2007 peak earnings level. Moreover, HSBC notes that the region is on a cyclically adjusted price-earnings ratio (Cape) of 11.4, compared to a long-term average of 15.
So Europe seems a solid long-term bet. But there are plenty of potential short-term obstacles ahead, ranging from rising bond yields – which imply higher borrowing costs for European governments – to another outbreak of the euro crisis. So those jumping in should invest in markets with Capes so low that any potential bad news looks largely factored in. Our favourite remains Italy, on a Cape of around 7.3. Investors can play it with the iShares FTSE MIB (LSE: IMIB).