2017 Outlook: Economy and Uncertainty Gather Pace – Part II

• Dr. Jan-Carl Plagge, Head of Applied Research
  

In the first dispatch of PULSE ONLINE’s 2017 markets outlook, accessible here, we reviewed strategists’ predictions for European equities this year.

The average forecast from five strategists¹ calls for the STOXX® Europe 600 Index to end 2017 at 367, an uptick of almost 2% from the 361 level on Dec. 31, 2016. That excludes dividends, which amounted in 2016 to a 2.9% extra return for the benchmark. They predict no change for the EURO STOXX 50® Index, and gains of 4.6% for US stocks.

This upward trajectory will be dependent on the relationship between an expected earnings recovery and valuations. Profits for companies in the EURO STOXX 50, for example, are likely to expand by 11.6% in 2017, according to FactSet, after stagnating for six years.

Earnings recovery

Still, equity forecasts could well prove conservative. While earnings have been predicted to grow every year before they almost consistently disappointed, this time they have several underpinnings, UBS equity strategists say². The Swiss bank expects European corporate profits to grow 8% in 2017 on higher commodity prices and a pick-up in inflation that is positive for revenue growth. Should equity valuations stay at current levels, it would imply an 8% advance for equities in the year. 

Further upside potential

But investors may start paying more for equities too. The drivers for that may be: money flows coming from bond investments as yields rise, and the potential for fiscal stimulus from European governments.

Despite recent gains, valuations aren’t stretched: European equities are trading in line with their historical average valuations, and cheaper relative to earnings than in previous cycle highs, according to STOXX data. The EURO STOXX 50, for example, is currently priced at 17 times the earnings of its members³. That compares with 20 times for the STOXX® North America 50 Index, the data show.

Room for increased volatility

There are well-flagged political events that will have investors on edge about the prospects for risky assets in Europe. High among them: Dutch, French and German elections in 2017, and the official start to the UK’s departure from the European Union before the first quarter is over.

Investors seeking relative protection against European risk and market downturns could consider strategies such as low volatility (STOXX® Europe 600 Minimum Variance Unconstrained) or geographic diversification of revenue sourcing (EURO STOXX® International Exposure). 

If 2016 taught many a lesson is that forecasts and expectations can be shattered by reality. The experience with surprise election results (Trump, Brexit) is likely to add to the political and market uncertainty in 2017, at a time when asset valuations are already pricing in a better outlook and there is much room for increased volatility. 

A PULSE ONLINE article next week will cover the outlook for fixed-income and currency markets.

 

¹ Strategists at Barclays, Credit Suisse, Goldman Sachs, Societe Generale and UBS.

² “European Equity Strategy,” UBS, Nov. 15, 2016.

³ Excluding negative earnings.