International Outlook: Europe Is Looking Up | American Funds

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2018 outlook

International Outlook: Europe Is Looking Up

Key Takeaways

  • Improving economic growth in Europe and Japan, coupled with attractive valuations and a weak dollar, have produced the most encouraging outlook for international investing in years. Investor sentiment has soared as political uncertainty diminished.
  • International equities are outpacing U.S. equities for the first time in nearly a decade. That trend may continue as Europe and Japan have taken longer to recover from the global financial crisis and, therefore, potentially have more room to run. 
  • The European Central Bank and Bank of Japan continue to inject massive amounts of stimulus into their respective economies, priming the pump for additional growth and inflation in the years ahead.
     

As Global Economy Gathers Strength, Europe Is Looking Up Economy, Markets and Corporate Profits Are All Headed in the Right Direction

LI50-Chart 1

Sources: FactSet, MSCI, RIMES, Thomson Reuters. Total return is in local currencies as of 10/31/17.

Europe has enjoyed a remarkable recovery in recent months, driven by a powerful combination of central bank stimulus, ultra-low interest rates and improving growth. But perhaps the most important influence on investor sentiment is what didn’t happen in 2017: the European Union didn’t collapse under the weight of nationalist, anti-EU movements that had posed a significant threat during a year that featured pivotal elections in France and Germany.

If anything, the future of the 28-nation economic union looks stronger now than it has in years, despite the U.K.’s expected departure in 2019. Fears that France, Italy and Greece might follow the U.K.’s Brexit path have dissipated as continental Europe has essentially lined up in support of the EU’s governing authority. As a result, the euro has strengthened against the dollar and Europe has enjoyed a surge of financial asset inflows.

Meanwhile, euro-zone economic growth is gradually catching up to the U.S. Third-quarter GDP in the 19-member euro zone grew at an annualized rate of 2.5%, and the unemployment rate has fallen to 8.9%, its lowest level since 2009. Moreover, corporate earnings are up across the board, led by a strong rebound in the energy, mining and banking sectors, thanks in part to the strengthening global economy.
 

Europe and Its Factories Are Back in Business 31 of 32 Countries Tracked Are in Expansion Territory

LI50 - Chart 2

Sources: Capital Group, Haver as of 9/30/17. The Purchasing Managers’ Index is an indication of whether business conditions for a number of variables in the manufacturing sector have improved, deteriorated or stayed the same compared to the previous month. An index reading above 50 indicates an expansion, whereas a reading below 50 indicates a contraction.

Europe’s manufacturing activity — previously a weak point on the region’s path to recovery — has increased dramatically, supported by rising orders for everything from new aircraft to highly sophisticated technology components. In fact, many euro-zone factories have reported labor shortages amid the surging demand. Factory activity has expanded in all major European nations, led by manufacturing powerhouse Germany and the neighboring Netherlands.

Despite these encouraging signs, however, the European economy continues to struggle with deflationary pressures. Core inflation, excluding volatile food and energy prices, fell to 0.9% in October, its lowest level since March and far below the European Central Bank’s 2% target. This persistently weak trend prompted the ECB to extend its massive bond-buying stimulus program through September 2018 in an attempt to boost lending and support further economic growth.

Thanks to improving global growth, select European companies are thriving — particularly those that operate on a global stage. Dutch semiconductor equipment-maker ASML, for instance, has continued to exceed earnings expectations, benefiting from soaring demand for computer chips used in mobile devices. The so-called internet of things investment theme is alive and well in Europe, powered in part by Dutch technological innovation.
 

Weaker Dollar Could Boost International Equities Longer Term, Look for Extended Strength in Non-U.S. Currencies to Further Fuel Overseas Returns

LI50 - Chart 3

Sources: RIMES, Thomson Reuters as of 10/31/17.

Currency trends have formed a nice tailwind for dollar-based investors in international equities. After the dollar peaked in early 2017, the currency effect on overseas investments reversed from previous years, when a strong dollar hurt returns. With the dollar slipping in 2017, European equities have far outpaced U.S. stocks in dollar terms. The dollar also has declined against many other currencies, including the yen, producing a similar tailwind for Japanese equities.

Investors should keep a close eye on this trend, however. Improving U.S. economic growth, gradually rising U.S. interest rates and the European Central Bank’s stimulus-program extension combined to push the dollar higher in September and October. Capital Group currencies analyst Jens Sondergaard believes this near-term dollar strength will fade, and that the dollar will continue its decline through 2018 and into 2019.

In the financials and industrials sectors, a valuation gap has emerged between some European and U.S. companies. Airbus and Barclays, for example, have recently traded at significant valuation discounts to comparable companies in the United States. The gap has started to close in other sectors as European equities have rallied, but these two sectors remain areas of potential opportunity for value-oriented investors.


What This Means for Portfolios

After years of lagging U.S. stock market returns, many European and Japanese companies remain attractively valued. Seek meaningful exposure to Europe and Japanese companies that stand to benefit from a strengthening global economy. Go to our Portfolio Playbook for more detail.

 


 

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Content contained herein is not intended to serve as impartial investment or fiduciary advice. The content has been developed by Capital Group, which receives fees for managing, distributing and/or servicing its investments.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and not to be comprehensive or to provide advice.