European recovery to stay on track in 2015

In the UK and the US, the debate has now moved to the pace of recovery from the post-crash recession; in Europe, the issue is more whether the region can convincingly claw its way out of the slump. The economic signs are not encouraging.

The euro area grew by just 0.8% in the third quarter of 2014, compared with the previous year; the slide in Germany - still the engine of the European machine - from 2.3% in the first quarter to 1.2% in the third is particularly worrying.

Too many of its banks are still failing stress tests, inflation remains low and the European Central Bank (ECB) has yet to demonstrate that it is prepared to take decisive action.

But some of our expert forecasters think there are glimmers of light amid the gloom. Paul Niven, manager of Foreign & Colonial investment trust, says: "If you are prepared to take a long view, there are several aspects in Europe's favour."

Improvement in growth

First, its stockmarkets are relatively lowly valued, with many of its quality companies trading at discounts to their US counterparts.

'The growth outlook has been poor across the board but I think the decline in the euro and the fall in commodity prices - although the latter has been offset by the euro's fall against the dollar - is likely to lead to an improvement in growth across the eurozone in 2015. It will not be a strong upturn but I think the disappointing euro area growth is coming to an end.'

He adds that, while the US is likely to start tightening fiscal and monetary policy this year, Europe will be going in the opposite direction. That means downward pressure on the euro will continue, which should be positive for growth and corporate earnings.

Jeffrey Taylor, head of European equities at Invesco Perpetual, agrees that the disappointing recent data "fails to reflect the entire economic picture". He adds: "While the eurozone economy is taking longer to heal, we believe that recovery is still on track and the reality is that Europe is expected to show positive growth this year and next.

"Unemployment has ticked lower over the last 12 months. The credit cycle is showing signs of progress, with the October 2014 ECB bank lending survey continuing to point towards improvement in both credit standards and demand for credit in the eurozone."

Taylor also believes that some of the major headwinds faced by Europe over the last few years are now fading, as households and companies continue to reduce their debts and banks are getting recapitalised. "These trends should support a gradual improvement in economic activity."

Company news should also become more encouraging. While corporate earnings in the US are close to their peak, in Europe they are still around 30% below the 2007 peak; but Taylor points to encouraging signs towards the end of 2014 which, combined with the weakening of the euro, should mean earnings will start to grow again.

"This offers great opportunities in our view and we would question the still very depressed valuations of the market as a whole."

Downside risk

While some investors are still buying into the more defensive areas such as healthcare and food, Taylor prefers cyclical sectors, such as financials and industrials, as the valuations of the former mean there is a risk on the downside.

"The risk-reward profile of other sectors, such as financials, some cyclicals and energy, remain much more attractive in our view - especially with current valuations significantly below historical averages and earnings poised to recover from the dip, even in a modest growth environment. We maintain our positive outlook for European equities and continue to favour those sectors more sensitive to economic cycles."

Paras Anand, head of European equities at Fidelity, thinks corporate activity could be a further positive for European stockmarkets. "In the absence of a comprehensive pick-up in end demand, companies will seek to deliver long-term value to shareholders through industry consolidation or, as we have started to see particularly in Europe, through substantive portfolio restructuring.

"We should start to feel the early benefits going into 2015." He also thinks deflation, which is seen as the big negative for Europe by most commentators, could actually be a positive factor.

"Over the last few years, one of the reasons why we have seen a collapse in inflation from the very steady long-term average of around 2.5% is the fact that an inefficient and expensive labour force across the region has had to absorb real wage reductions in order to adjust to a lower demand environment and the inability of governments to sustain historically generous employment terms.

"Additionally, we have seen broader input costs - energy, base commodities and technology - on a firmly downward trajectory. For a corporate sector of only modest capital intensity overall, this evolution will translate to higher retained earnings over time. Again, we could begin to see the benefits of this coming through in the year ahead."

Passive routes into Europe

As well as some of our favoured actively managed funds and trusts, which we outline in our Rated Funds sections, you can find a few cheaper passive versions below.

Cheap exposure to European stocks can be achieved with the Vanguard FTSE Developed Europe ex-UK ETF, which has a TER of just 0.12%. Over the year to 21 November it has returned 4.4%.

For income seekers, the SPDR S&P Euro Dividend Aristocrats invests in the 40 highest-yielding companies in the S&P Europe index with a 10-year record of dividend growth. It is down 1.2% on the year.

The iShares MSCI EMU Small Cap invests in small companies. It has a TER of 0.58% and returned 0.75% over the year.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.