By Viktor Nossek, Director of Research, WisdomTree Europe
Viktor Nossek, Director of Research at WisdomTree Europe.
Macro Outlook for Europe: Structurally-Led, Europe’s Domestic Growth Presents an Opportunity For Small-Caps in 2017
Europe’s investment case is underpinned by a structurally-led – and not a cyclically-led economic recovery. We anticipate growth to pick up over the course of the next 12 months, propelled by consumer spending mainly in the Eurozone and the UK, along with a modest pickup in investment spending. Net exports and government spending will work as stabilisers but not drivers for growth.
This recovery is unlikely to be cut short by political uncertainty despite talk of triggering Article 50 in the UK and the 2017 general elections in France and Germany: Brexit is already priced-in. The floor to Europe’s downside risk to political events remains the ECB ultra-loose policy stance.
More fiscal stimulus and QE directed towards long term bonds boosting strategic investments in Europe are expected in 2017. Suppression of high-grade bond yields and flat yield curves will continue to justify a re-rating of European equities.
Our investment case for Europe is clear: domestic growth and quality, small caps and broad exposures emphasising the consumer and industrials sectors.
Positioning for European growth with small cap dividend payers
Chart 1 summarises our investment case for Europe. It shows the performance of the WisdomTree Small Cap Dividend strategy since July 2006, broken down by its core components: dividends, earnings and valuation. It shows how the cumulative contribution of each has shifted gradually towards strengthening equity fundamentals: stable dividend returns, falling valuation risk and rising earnings.
Source: WisdomTree, Data as of 31 July 2016.
As has been the case for all risk assets, the ECB’s actions in 2012 to restore confidence in Europe’s banking sector and bond markets has triggered a major re-rating of equities, including European small caps. This re-rating continued as exceptional monetary stimulus by the ECB and recently the BoE pushed bond yields of European high-grade issuers to historic lows.
But since mid-2015, the performance of Europe’s small-cap dividend payers has been increasingly carried by strengthening fundamentals that have underpinned their re-rating: earnings have started to accelerate and together with steady dividend streams, which have accounted for nearly half the shareholder’s net total return over the entire equity market cycle, have caught up with stock prices.
In our view, it’s a result of a resilient and more confident consumer in Europe who, coupled with banks acting as willing lenders and monetary policies stimulating investments, underpins a sustainable path for stronger economic growth. Biased towards Consumer Discretionary, IT, Industrials and Financials, the basket is well positioned for the domestic demand-led transformation of Europe.
Improved competitiveness and easing credit conditions bolsters spending power
Chart 2 shows how Eurozone’s economic rebalancing since 2010 – away from cyclical, export-led to structural, domestic demand-led – has broadened-out growth and laid the foundations to quicken the pace of expansion similar to the UK. Driving this trend into 2017 is a more competitive labour force and banks willing to extend cheaper loans.
Source: WisdomTree, Bloomberg. Data as of Q2 2016.
(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)