Europe: Poised to Shine

Investing Daily Article of the Week

by Ben Shepherd, Investing Daily

As it shakes off the political dysfunction, financial crises and recessions of 2013, Europe is enjoying a recovery that should accelerate in 2014. Indeed, European stocks are set to outperform this year.

In 2013, Europe’s performance wasn’t exactly shabby, either. US stocks locked in their best year in decades with the Dow Jones Industrial Average up 27 percent in 2013 and the S&P 500 up 30 percent. But the Continent kept pace, despite a host of challenges.

London’s FTSE 100 finished the year 14 higher while Germany’s DAX Index shot up by 26 percent, as Europe’s economic woes finally began waning. The final quarter of 2013 saw several of the region’s economies return to growth as the European Union’s (EU) sovereign debt crisis eased.

Revenues at many European companies have been growing over the past year and margins are generally expanding. Earnings also grew on average in the high single digits last year and are expected to outpace those of US companies in 2014.

That’s largely due to the fact that while the European Central Bank (ECB) has maintained an extremely accommodative monetary policy, the pan-European government took a different approach to the region’s debt crisis than its American counterpart. The US relied primarily on stimulus efforts to grow out our recession, but theEU forced a tough program of austerity on its debtor governments and compelled them to bear most of the pain of the crisis.

Given those different approaches to crisis management, while European stocks are up by more than 140 percent since their 2009 lows, in economic terms Europe’s economic recovery is at least a couple of years behind America’s.

Risks still lurk in Europe. Many EU countries continue to carry what appear to be unsustainably high debt burdens and most of the region’s banks still hold substantial amounts of sovereign debt. But given that Europe is in a nascent recovery stage, its expected 1 percent growth in gross domestic product in 2014 should create better than 14 percent growth in earnings per share (EPS), thanks to this low base. Some investment banks are even more optimistic, with UBS (NYSE: UBS) forecasting average EPS growth in the region of 30 percent.

But even as the recovery is gaining momentum, the ECB is expected to maintain its extremely dovish stance. The will weigh on the euro, particularly relative to the US dollar as the US Fed tapers back its bond purchases, giving the region’s exporters a strong competitive advantage.

In light of the tear American equities have been on over the past three years, 2014 will likely be a much better year for European stocks than for those in the US.

In the early stages of the US economic recovery, the financial sector outperformed and, odds are, the case will be much the same in Europe. While risks continue looming on the balance sheets of major European banks such as HSBC (NYSE: HSBC) and BNP Paribas (OTC: BNPQY), these firms will experience significant margin expansion as Europe’s economy returns to growth even as the ECB remains accommodative and might even undertake additional stimulus measures to avoid deflation.

Technology names such as SAP (NYSE: SAP) and Royal Philips (NYSE: PHG) will also get a boost from a pickup in both business and consumer spending. Businesses have been dragging their feet on technology upgrades thanks to the weak business environment. Sagging consumer confidence also helped to push the region’s personal savings rate up to a recent high of 13.1 percent in the euro zone in the second quarter, but that number should start creeping down as the economy improves.

So while the US economic recovery has become old news, Europe will likely be the real success story in 2014 and should gain momentum into 2015 as economic growth continues to accelerate. Don’t underweight emerging market stocks and certainly don’t dump the US, but Europe will be the big winner in the new year.