Despite negative returns for the MSCI Europe Index last year and a 5% decline this year, these markets are still not cheap. Prices for European equities declined fairly steadily last year and the first six weeks of 2016, as earnings forecasts were revised downward, consistent with the weakening earnings and economic backdrop. Stocks and growth forecasts have rebounded with energy prices more recently. But have they fallen enough to make Europe attractive, considering this background? Data suggest that they have not [Figure 3]. Forward valuations for the market suggest a PE of around 15x expected 2016 earnings. This is consistent (if not at a premium) with the longer-term average for the market.
Currency matters for European investments, but can have both positive and negative effects. The euro declined last year against all of Europe’s major trading partners, including the U.S., Japan, and China. This provided some boost to export-oriented companies, though clearly not enough to have a major impact on overall earnings. However, the declining euro also impairs returns for U.S.-based investors. Our expectation is for the dollar to be more stable this year.
The significant wildcard of the “Brexit” remains. Should Britain leave the EU, we would expect significant currency weakness versus the U.S. dollar and other currencies, almost certainly in the British pound, but also likely in the euro as well. In our view, given current equity market valuations, investors are not being rewarded for taking on the politically induced currency uncertainty.
CONCLUSION
European companies and equity markets’ performance has been a disappointment. The major underperformance of companies relative to expectations has made analysts pessimistic for this year as well, forecasting just 2.9% earnings growth for all of 2016. At this point, nothing in the political or economic environment is suggesting a significant reversal in this position; if anything, the political issues in Europe are adding uncertainty to the market. Given current valuations, we do not believe investors are being rewarded for this uncertainty. For the foreseeable future, we will remain cautious on the European market.
Burt White is chief investment officer at LPL Financial..jpg)
CURRENCY MATTERS