However, Europe is also facing greater headwinds this year, limiting the scope for further upgrades to growth and earnings forecasts.
After the strong returns of the past couple of years, more modest gains in the year ahead seem likely. However, there is significant scope for a rotation of sector performance. Some areas, such as industrial cyclicals, commodity-related shares and smaller companies in general are more than fully reflecting improvements to European economic growth and profits. Other “steady growers” in a range of sectors – construction, media, pharmaceuticals and certain consumer-related stocks – remain overlooked.
While little is expected of Europe’s consumer, demand is well supported by the healthy state of household finances and is being stimulated by strong housing markets. In addition to the latter, robust infrastructure spending and the increasing role of public-private partnerships in parts of Europe are helping construction-related shares. Low real interest rates, which are still negative in some regions, also continue to help the trading environment for these companies.
Valuations for industrial cyclicals, on the other hand, already reflect expectations for further strong improvement in the economy. The recent surge in Germany’s key Ifo business sentiment survey to a near-quarter-century high of 102, however, leaves little room for further upside surprises. Industrial surveys and corporate profits have also been helped by the sell-off of the euro last year, and a boost from this source may be harder to repeat.
Analysts’ estimates of 10 per cent overall earnings growth for European companies in 2006 may be slightly optimistic. While European companies have done a great job of closing the profitability gap with their US and UK peers in recent years, the overall return on equity (ROE) and margins implied by analysts’ forecasts are also now well above their long-run averages.
Europe also remains attractively valued compared with other major markets, which are vulnerable given higher expectations and, in the case of the US and UK, record levels of debt. While Europe is not expected to be immune from any correction in global stock markets, domestic European demand would be solidly underpinned in the event of a slowdown in world growth.
Jeff Taylor, head of European equities, Invesco Perpetual.
