It's Springtime for Investing in Europe -- Heard on the Street

By Richard Barley Features Dow Jones Newswires

The U.S. led the reflation mania in markets at the end of last year. But Europe, despite persistent fears about political turmoil, is the economy that is surprising investors this year. Stronger nominal global growth should give European stocks a further lift.

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On growth, Europe is outshining the U.S. Eurozone data released Wednesday showed eurozone gross domestic product in the first quarter grew 0.5% from a quarter earlier. That equated to an annualized growth rate of 1.8%, versus the 0.7% recorded in the U.S. in the first quarter. Monetary policy looks set to remain extremely loose, further supporting the economy.

The bigger factor for investors in Europe may well be the recovery in inflation, and hence the better outlook for nominal growth, which translates into higher top-line growth for companies. After all, real gross domestic product has been growing steadily in the eurozone over the past few years, but that hasn't been much help to stocks--until now.

A number of headwinds appear to have abated, with the recovery of commodity prices, a turnaround in emerging markets and a global recovery in inflation. The latter hit the eurozone hard, as it was at the center of the deflation scare, and European stocks looked particularly vulnerable, with big exposures to financials and energy. European profit margins have tended to track developed-market inflation closely, Barclays notes.

Europe could thus look brighter yet. There are some signs of this already: a Morgan Stanley analysis of first-quarter results from 113 European companies showed a net 23% beating earnings estimates by 5% or more, and 41% beating revenue estimates by 1% or more. The latter is the best reading on record with data going back to 2003.

Some of this improvement is already priced in. The forward price/earnings multiple for the Stoxx Europe 600 has risen to 15.3 times, according to FactSet, from 14.8 times at the start of the year. But earnings are still depressed, and flows into Europe are only starting to turn around. U.S. investors sold European equities for 11 straight months in 2016, but in March inflows picked up to the fastest pace since October 2015, UBS notes.

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European political risk is fading, and should dissipate further if the second round of France's presidential elections Sunday results in a victory for centrist Emmanuel Macron over euroskeptic Marine Le Pen. The chance of a flare-up in the Greek debt crisis has fallen too with this week's deal with its creditors. That leaves investors focusing on the reflation in European earnings. It's springtime for European stocks.

Write to Richard Barley at richard.barley@wsj.com

(END) Dow Jones Newswires

May 03, 2017 08:40 ET (12:40 GMT)