New Catalysts for Investing in Europe

European stocks have underperformed U.S. equities for years, but now valuation, economic, and policy catalysts loom that could make this a good time to add them to your portfolio.

For most of the past 10 years, European equities have disappointed investors. While the S&P 500 is up four-fold since the low in March 2009 during the financial crisis, the MSCI Europe Index has only doubled. This isn’t the first time in the last year that my colleagues and we have pointed out that Europe seems unloved and under-owned by investors.

Now, however, we see several positive changes taking shape that suggest a short-term opportunity, even though the region still faces long-term structural, political, and fiscal obstacles. Below are five reasons investing in European equities may make sense in 2020, a year in which the dominance of U.S. stocks may start to fade:

• Evidence of an improving economy is starting to appear. A measure of economic surprises is at a two-year high, indicating economic growth, which disappointed in the fourth quarter of last year, may start to exceed forecasts, and manufacturing readings are starting to perk up. Positive earnings revisions may not be far behind. Lower levels of uncertainty around Brexit and trade policy should contribute to more corporate spending and improved growth.

• Accommodative central bank policy remains in place. Interest rate cuts and monetary supply growth implemented last year continue to stimulate the economy. The yield curve, an important barometer of economic health, is steepening (a good thing), while banks are posting positive earnings revisions. We think there could be another interest rate cut in the U.K. to hedge the economy against the risks of Brexit. That would also likely spur growth.
  
• More fiscal stimulus should be coming. We expect incoming European Central Bank President Christine Lagarde to be an advocate for increased government spending, given her interest in climate change and the impact of technology on labor markets. A big jump in spending is already in the pipeline for 2020. That should bump up GDP growth.

• Sentiment factors are positive. Skepticism remains high among investors. Europe is the least-owned region among hedge funds and has experienced the worst outflows of any region in the past two years. Such factors are often considered positive buy signals since they indicate the potential for investors to buy back into a region once improvement is obvious.

• Valuations are compelling. The price-earnings ratio (a popular valuation measure) of the MSCI Europe Index is 15, compared to 17 for the MSCI All Country World Index and 19 for the S&P 500. U.K. stocks trade at an even steeper discount than the rest of the world. 

Investors should watch for economic improvement in Europe to lead to positive corporate earnings revisions. 

Investors should also look to use actively managed funds when they add international exposure. Look for funds that emphasize economically sensitive companies in the U.K. and Europe. While European stocks have turned up in recent months, there still seems to be time left to add them.