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Does this 'consensus trade' still have further to run? – FE Trustnet

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Emerging market and European equities are becoming consensus trades, according to BlackRock’s Richard Turnill, but he nevertheless believes both market areas have further to run.

Throughout the course of 2016, the MSCI Europe ex UK was one of the worst-performing major regional indices and the MSCI Emerging Markets index was one of the best, as geopolitical uncertainty deterred investors from buying into developed markets and encouraged them to look elsewhere for returns.

Performance of indices in 2016


Source: FE Analytics

It is a different story year-to-date, however, as MSCI Europe ex UK is now at the top of the pack with gains of 15.03 per cent, which could have been the result of the French and Austrian elections as well as attractive valuations on a relative basis at the start of the year. MSCI Emerging Markets continues to do well, with a year-to-date return of 13.6 per cent.

In contrast, the likes of the S&P 500 and the FTSE 100 indices are trailing behind with respective gains of 4.61 and 7.47 per cent.

In his latest report, Turnill said: “Many investors have flocked to emerging markets and European equities this year, as money has broadly flowed back into risk assets. Our analysis suggests these equity trades are becoming consensus, but we believe they still have room to run.

“Emerging markets and European stocks look more popular than last year, based on an analysis of flows, price momentum and positioning by Blackrock’s Risk and Quantitative Analysis team. Yet these asset classes do not appear excessively crowded (a score above two). In contrast, positioning in US credit looks more stretched.”

The global chief investment strategist said he views crowding as a heightened risk rather than a signal to sell. Year-to-date, he pointed out that there have been large inflows across asset classes as investors have become less concerned about economic and geopolitical risk.

“Nearly $170bn has flowed into global bond funds year-to-date, and $140bn into global equity funds, EPFR Global data show. At the same time, money market funds have experienced notable outflows,” he explained.

“Emerging markets and European stocks are no longer the contrarian trades that they were for much of 2016, but we believe there’s still a strong case for exposure to international stocks. Our ‘risk ratio’ gauge of risk appetite is at levels consistent with moderate risk taking, but nowhere near the ‘irrational exuberance’ seen in the late-1990s or mid-2000s.

“Strong inflows year-to-date have only replaced a quarter of the outflows from emerging markets stocks between the 2013 ‘taper tantrum’ sell-off and mid-2016, and only 17 per cent of the flows out of European equities last year.”

Turnill said taking risk in equities over credit is preferable in the current environment, as the latter is more crowded and more expensive. That said, he still sees some opportunities in high-quality US credit.

“Global reflation, a strong earnings recovery and attractive equity risk premiums also should support international stocks,” he added.

The latest report from Natixis’s David Lafferty, published at the start of the month, also said European equities present the best opportunities at the moment amid toppy valuations across asset classes.

“The coast now seems clearer for opportunities in European equities,” he said. “The Eurozone recovery is finally taking hold, with growth looking more solid and broadening across countries. Quarter-on-quarter growth has been picking up, pointing to a moderate cyclical upturn. We are also finally seeing improving credit flows following the European recessions of recent years.

“Encouragingly, it appears that the European Central Bank is winning its war on deflation, with inflation data closer to the central bank’s “just below but close to 2 per cent” target and core inflation stable around 1 per cent.”

Not only this, Lafferty explained that inflation is unlikely to run away given the base effects of oil prices. As such, he believes the European Central Bank is unlikely to aggressively reduce stimulus which means European equities will remain supported.

The chief market strategist added that the weak euro will continue to boost exporters and, with the French election behind us, European assets could begin to rally further.

Performance of currency vs US dollar over 5yrs


Source: FE Analytics

“While not inexpensive in absolute terms, we believe that European equity markets continue to look relatively cheap versus other regions, particularly the US,” Lafferty continued.

“Despite the rally since November, P/Es are reasonable compared to historical averages. For example, the MSCI Europe ex UK index estimated 2017 P/E is trading around 15.7x, versus a long-term average around 13.6x.

“Moreover, many European stocks, including small and mid-caps, are trading at a significant discount to their US peers. While a lot of this was explained by political risk, we believe there is now ample room for European equities to begin catching up to US markets after almost seven years of underperformance (in local currency terms).”

Jason Hollands, managing director of Tilney Bestinvest, said European markets have a greater bias towards more cyclical and operationally-leveraged traditional indices, which should perform well in an environment of improving global growth.

“I agree that this probably has further to run as many international investors, notably US money managers, have long been underweight Europe,” he explained.

“With valuations stretched in US equities and an unravelling of the Trump trade, there is clearly scope for a shift in asset allocation in favour of European stocks. This should prove supportive to markets at a time when monetary policy also remains highly accommodative.

“Tilney remains overweight European equities in our managed portfolios. Funds we like including Jupiter European, Henderson European Focus and Threadneedle European Select, as well as the small-cap focused Baring Europe Select fund.”

Adrian Lowcock, investment director at Architas, warned that Europe is not cheap even compared to its own history and said the gap with the US has narrowed over the past year.

That said, he reasoned the region is still much further behind in its recovery and companies have a greater opportunity to boost their profits, so the region is still attractively valued.
“Europe has seen a lot of investor money comeback, but it has yet gotten to the point of a crowded trade,” he said. “Investors in the UK tend to be significantly underweight Europe as they often avoid the region because of its complex political landscape.

“This ignores the fact that European markets offer investors access to many global companies as well as more domestically focused businesses which have access to a market of over 440 million people.”

Neil Shillito, fund manager at Downing, argued that Europe has undergone a prolonged period of economic paralysis to the point where the equity market has become seemingly cheap.

“Certainly it would be hard to describe the recent turnaround as driven by growth; what evidence is there that stocks will continue to grow irrespective of their current price?,” he pointed out.

“My preference for Jupiter European Growth might seem to be counter-intuitive when measured against my value sentiment, but Alex Darwall is a seasoned investor and any periods of ‘under-performance’ should always be seen against a back-drop of how he is positioning the portfolio for the future.”

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