European & US Equities: Buying Opportunities In Sight

Growth & Inflation Fuel Earnings

The global equity rally over the first quarter of 2017 has been fueled by a combined uptick in both growth and inflation which has boosted earnings. For the first time since 2011, data surprises in both developed and emerging markets are firmly in positive territory, supported partially by the delayed effects of China stimulus. Consequently, after huge outflows in 2016, equities are experiencing a return of inflows.

Relative Value to Remain Supported

The data cycle is likely to normalise over the second quarter of 2017 but wider fundamental trends are likely to remain supportive. Monetary policy is gradually shifting with the ECB expected to communicate a further shift at their June meeting while the March FOMC confirmed that the Fed remain on course to gradually lift rates over the year. This environment is likely to nurture relative value in equities where risk premia can reduce amid an encouraging macro backdrop.

Risk Factors Remain

There are still some risk factors to consider, however. The upcoming French elections will be a key catalyst for markets, specifically euro area equities. However, the political risk premium in euro area equities offers good upside potential, on a risk-adjusted basis, in the context of strong data and an uptick in earnings. Outflows from European equities have been significant and the potential for investor buying in the aftermath of the French elections portends a strong rally as European risk premia shrink.

US Equities Outlook

Looking further down the year, there appears to be strong upside potential for US equities fueled mainly by the prospect of tax reform. However, with the Trump administration failing to pass their health care reform, markets are currently wary about their ability to follow through on other proposals such as tax reform and infrastructure spending. This period of uncertainty is likely to lead to further unwinding of US equities but should ultimately provide better levels to buy into for the remainder of the year. While markets await further information on the US fiscal path, traders can focus on European equities.

French Elections in Focus

During this recent period of elevated uncertainty in the run-up to the French elections, European markets have underperformed the global index. Investors have significantly de-rated European equities with high exposure to France. Indeed, the aversion to domestic European assets isn’t just focused on France but across most euro area countries. Equities with a high euro area revenue exposure have been sharply de-rates by investors who appear, once again, to be pricing in a euro area recession despite the strong upturn in economic data.

Essentially the key focus point for investors at this stage is the prospect of a Eurosceptic party achieving power this year. With the Dutch and Austrian elections having passed, the focus now is on French, German and Italian elections. Populist support in France has been strong, however, Le Pen is widely pegged to lose in the second round of voting with centrist candidate Macron having seen a surge in support recently. Indeed, it was reported over the weekend that nine centre-right law makers, aligned with rival Fillon’s party, will back Marcon. The odds offered by poll makers and betting markets have Le Pen between a 25% and 33% chance of winning. While these odds are clearly disputed following Brexit and the US elections it is worth noting that in each of those cases the margin between the two outcomes was far smaller than it is here.

In the context of a likely Macron victory, the de-risking through fund outflows, high-risk premia an internal valuation dislocations suggest that if Le Pen doesn’t win, there will be plenty of scope for a sharp rally in European equities.