Following the European Central Bank’s massive quantitative easing programme, which was announced in November last year, European equities have rallied perhaps a bit too much, according to the firm.
“Given that valuations are sitting at a 10-year high on a forward price-to-earnings metric, strong earnings growth is increasingly necessary to justify these valuations,” the firm said.
“It is unlikely that European equity markets will be able to maintain the momentum seen so far this year and record another 15% gain through the end of 2015."
Based on the results from 96% of companies listed on the Euro Stoxx 600-listed, the firm estimates companies saw a 9% year-on-year growth in earnings per share during the first quarter while sales growth was 7.9% year-on-year.
Tilt to cyclical stocks
Macro tailwinds, including lower fuel prices, a weaker euro and improving credit dynamics have helped companies improve first quarter earnings, the firm said.
The earnings outlook for the rest of the year remains upbeat, as many of these tailwinds are likely to persist and a broader economic recovery should support markets.
A healthy overweight towards export-oriented companies has worked well for investors over the past 12 months. But relying on currency weakness to support earnings is the wrong approach. Instead, the firm recommended that investors should focus on the long-term and tilt to cyclical stocks, which should benefit from the ongoing domestic recovery.
Financial sector catching up?
The financial, industrial and consumer discretionary sectors saw improvement in earnings growth, suggesting these companies may already be seeing the benefits of an uptick in economic activity.
The financial sector is the only part of the European equity market not to have recovered its losses since the financial crisis, the firm added.
“Financial stocks have not been investors’ favourites, and the banking sector, in particular, is viewed with a healthy degree of scepticism given worries over non-performing loans and the transparency of financial accounts.”
However, improvement in the credit cycle is an encouraging sign. As the economic recovery continues and credit conditions improve further, it should lead to increased lending and boost the profitability of financial firms, the fund house said.
A look at the three-year performance of European ex-UK equity funds registered for sale in Singapore and/or Hong Kong with a minimum three-year track record: