European equities are trading at roughly 1.5 times price-to-book value, a 10% discount to the 15-year average. In contrast, US equities are trading at roughly 2.8 times book value, which is a 10% premium to their long-term average.
“While slower growth, low inflation and the lingering geopolitical risks associated with Greece and Russia argue for some discount, the current one may be exaggerated,” Russ Koesterich, managing director and chief investment strategist said in a recent report.
Many investors have moved very quickly to overweight positions in European equities, resulting in a rally.
However, if earnings are unable to keep pace, the European market could become expensive, but less than the US, Koesterich said.
At the same time he highlighted that the recent surge of inflows into European equities only partially reverses the multi-year outflow that preceded it. This could potentially support the market.
Cyclical sector preferred
According to Koesterich, European equities are likely to benefit from higher exports, given that 50% of revenue for European large-cap companies come from outside the eurozone.
The weaker euro has benefitted European exporters, particularly automakers and industrial companies.
Therefore, the fund house sees the best opportunities in cyclical-growth industries such as automobile, durable goods and consumer discretionary companies.
European banks are also favored, as they are trading at a significant discount and are not as vulnerable as they were a few years back.
“European credit growth remains sluggish and many financial institutions still need to replenish their capital base. However, like the broader economy, there are signs of improvement and the assets are cheap.”
Fixed income-few opportunities
Even as BlackRock has a positive view on equities, it sees fewer opportunities in European fixed income.
According to Koesterich, nearly a quarter of European sovereign debt now offers a negative yield.
“Other than a couple of niche areas—for example, European high yield—there are fewer opportunities, particularly if a weaker euro further erodes the return from already low yields.”