Last year many investors “gave up on continental Europe”, says Stephanie Flanders in the Financial Times. Money flowed out of European stocks for the first time in five years. As 2017 dawned this made sense: “the risk of further populist upsets in Europe was all that anybody could talk about”. But the way things are going, investors who fled the continent in 2016 “may end up wishing they had given it one last shot”.
Last week the pan-European FTSE Eurofirst 300 index jumped to a 16-month high. The EuroStoxx 50 Volatility index, Europe’s equivalent of America’s Vix volatility gauge – which essentially tracks the level of fear in a market – dropped to the lowest level since its inception in 1999. Investors were relieved that “European markets cleared the first of a cluster of potential pitfalls”, says Digby Larner in Barron’s, when the Dutch election last Wednesday failed to produce the populist surge from Geert Wilders’s Freedom Party (PVV) that many had pencilled in.
The short-term relief was palpable, but the broader point is that “market judgements of populist political risks are flawed and sweeping”, says John Authers in the FT. Last year they underestimated the odds, causing a massive slump in sterling. Now, though, they may be overestimating them. One prediction market gave Wilders’s PVV an 80% chance of becoming the largest party last January.
Similarly, its odds of the leader of the German anti-immigrant AfD, Frauke Petry, becoming chancellor look “wildly overdone”. They are pegged at 11%, yet this would require her party to gain more than 50% of the vote – “the blackest of swans, far eclipsing the election of Donald Trump”. In France, Marine Le Pen has been struggling in the polls. The odds of Europe muddling through have improved.
If there is indeed too much political risk priced in, as Authers suggests, European stocks are a bargain. Consider that the FTSE Eurofirst 300 is on a price-to-book-value ratio of 1.8, as opposed to 3.1 for the US. The gap of 1.3 far exceeds that seen in 2010 before the sovereign debt crisis, when it was just 0.4.
In price/earnings (p/e) ratio terms, Europe also looks much better. Psigma Investment Management’s Daniel Adams told Barron’s that US stocks are on a p/e of 18, while their European counterparts cost 14.5. The average net profit margin is also much lower in Europe: 7% compared to 10.5% in America.
European equities’ greater exposure to global growth is a further reason to expect more scope for a big jump in European profits compared to US ones. With political risk overestimated, and the European and global economies gathering strength, there should be plenty of life in the continental markets yet.
Modi tightens grip on India
India’s prime minister, Narendra Modi, led his BJP party to a decisive victory in India’s national elections in 2014. And the momentum behind him shows no sign of running out. The BJP has won 312 of 403 seats in Uttar Pradesh, India’s most populous state, the biggest majority in the state assembly in 40 years, says The Economist. With his party dominant”, he looks near certain to win the next general election in 2019.
The decisive result in Uttar Pradesh also suggests that the BJP could win further state elections. That would give Modi’s party a stronger, if not dominant, position in the upper house of parliament (which is elected by the state assemblies). The BJP currently comprises 80 of 245 seats in the upper chamber. A larger presence there would facilitate further structural reforms.
Modi has made a solid start by pushing through a national sales tax to replace a “bewildering array of local ones”. Investors are encouraged by the political backdrop, says Shuli Ren in Barron’s, while the earnings picture is improving too. No wonder the NSE Nifty Fifty index has reached a new record high.