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February 17, 2015 9:13 am

Weak oil and euro

drive Europes QEfuelled rally
Andrew Bolger


European shares have raced ahead this year in spite of all the uncertainties
concerning Greece and Ukraine.
The combination of quantitative easing announced last month by the European
Central Bank and a thus far upbeat corporate reporting season has propelled the
Eurofirst 300 index 10.2 per cent higher since the beginning of January. This
compares with a 4.8 per cent increase in the FTSE 100 and a rise of just 1.9 per cent
in the S&P 500.

Despite the sharp re-rating of European equities in terms of price/earnings

multiples since 2012, sentiment towards Europe has remained weak, according to
analysts at Citi.
But there are signs this is changing. Europe has enjoyed the strongest net equity
inflows of any region so far this year, according to EPFR data.
This pick-up in net flows is the second notable turnround in an otherwise negative
trend in the past few years, after the revival of the second half of 2013 to the first
quarter of last year. That ended when euro-area purchasing managers indices turned
lower and European growth slowed, both negatively affected by events in Ukraine.
Unless hostilities in Ukraine, and accompanying sanctions worsen, or Greece moves
closer to exiting the euro area, we would expect this pick-up in net inflows to be more
durable, given the backing of ECB QE, say the Citi analysts.

Andrew Parry, head of equities at Hermes Investment Management, says the QE

announced by Mario Draghi, president of the ECB, has been an important factor in
lifting European equities, albeit from a low base.
Looking forward, the Fed will be at the very least holding its balance sheet flat and
could even reduce it as the year progresses, while the ECB is expanding its balance
sheet, says Mr Parry. There used to be the old phrase Dont fight the Fed now it
is Dont fight Mario Draghi. Undoubtedly for asset prices, central bank balance
sheets and policy action have a very big impact.

Of the companies in the Stoxx 600 that have so far reported earnings for the fourth
quarter of last year, 55 per cent have beaten analysts estimates, an improvement on
the typical figure of 48 per cent, according to Thomson Reuters. Revenues have
beaten analysts estimates for 58 per cent of companies to have reported so far
again better than the typical quarterly average of 53 per cent.
While it is too early to argue that we are in a new upgrade cycle, a combination of a
weaker euro, lower commodity/input prices and improving real/nominal growth
should help to support our expectations of 10 per cent plus earnings compound

annual growth rates in 2015-16, say the Citi analysts. This remains the foundation
of our bullish view on European equities.
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Mr Parry says there has also been a reversal of some of the headwinds that were
facing European stocks. The euro, which back in June was 1.40 against the dollar, is
now 1.14, providing a competitive advantage to exporting companies. Lower oil
prices have also helped and Europe is a big oil consumer.
Morgan Stanley analysts also believe that after four years of persistent growth
disappointment, Europe is on the verge of an upgrade cycle.
They say: European net earnings revisions have been in negative territory since
March 2011. Over the next couple of months we believe this series is likely to move
into positive territory as analysts adjust their forecasts for the significant moves
weve seen in foreign exchange, rates and the oil price.
Mr Parry says he is keeping a wary eye on the negotiations with Greece, and admits
its departure from the euro is definitely a tail risk that would cause severe problems
in Europe.
But we cant invest on tail risk: we have to focus on whats in front of us. So we are
nervous about that but we do believe a compromise will be reached.
Mr Parry stresses Europe is coming from a low base of expectations, and even as
relative optimists, he and his colleagues at Hermes are not talking about a boom, just
a relative improvement in conditions.
Spain has got good growth, Germany continues to power ahead even Portugal and
Ireland are doing well, he says. It is an uneven recovery, but it was always going to
be, and there are enough positives to think that maybe, for 2015 at least, Europe may
fulfil its potential.