DAVID HOLOHAN: Europe’s shares look attractive as US peaks

Investors experienced a very strong year during 2017, writes David Holohan.

Global stock market indices performed extremely well, generating gains in excess of 20% in the US and more than a 10% increase across many markets in Europe.

Levels of volatility were incredibly low during 2017 and set several records, reflecting an ongoing ‘buy the dip’ mentality among traders given the continual upwards bias in stock prices irrespective of negative surprises.

The past year can be best characterised as a “Goldilocks” environment for stock market participants — whereby global growth is the strongest in several years, monetary policy remains loose, keeping interest rates low, and corporate earnings have continued to move higher.

Politically, the anticipated fallout from the election of Donald Trump did not materialise and, if anything, his inability to pass meaningful legislation for most of the year resulted in limited political interference for the US economy.

In Europe, while there were several elections that showed further gains for far-right political parties, equity markets shrugged off the results as the perception remains that the EU will continue to stumble through any setbacks rather than break up, which had been a distinct concern several years ago.

For the UK, it was very much an annus horribilis. Prime Minister Theresa May continues to struggle to reign in her own cabinet, let alone make meaningful progress towards Brexit, which is quickly approaching the one-year countdown point.

The Government also has to deal with a slowing economy and higher inflation.

Looking towards 2018, many of the economic themes present for the past 12 months are likely to continue for the next six months.

Global growth indicators suggest that both developed and emerging markets will continue to expand at a healthy rate, albeit growth rates can be expected to start to decline in the second half of the year.

Measures of inflation are the most important economic indicators to watch over the next 12 months.

Despite the many trillions of euro deployed by global central banks over the past decade to stoke economic growth, inflation indicators remain stubbornly low. If this was to change, interest rates could rise at a faster than anticipated rate.

From a commodity standpoint, with oil prices currently at around $60 per barrel, a stronger case can be made for prices to move lower from here than meaningfully higher.

The Organisation of the Petroleum Exporting Countries (Opec) will start to roll back from its supply cap in 2018 while US shale oil output is expected to continue to grow during the year.

Mr Trump’s recently passed tax bill will provide a boost to corporate earnings both for US companies and international businesses that have significant exposure to the US economy.

From an Irish standpoint, companies such as CRH, Kerry Group, and Glanbia stand to be beneficiaries of the corporate tax rate reductions.

From a political standpoint, 2018 looks set to be a very interesting year, particularly across Europe.

The recent Catalonian vote is a major embarrassment for Spanish Prime Minister Mariano Rajoy and it remains to be seen what the impact will be in the year ahead.

The upcoming Italian general election, scheduled for March, looks set to be an explosive contest, which, given the level of dissatisfaction with the EU in the country, stands to make the result the most watched political event of the year.

In the US, it remains to be seen at what point investors become more concerned by the Trump administration, as rumours abound of several imminent departures at cabinet level.

The president has also drained the federal coffers to provide the corporate tax cuts, limiting his ability to deliver on infrastructure spending promises in the year ahead.

For US equity investors, the highs for the year may come early in 2018 as stock markets have already priced in the Trump tax cuts.

The largest US technology companies that propelled markets higher in 2017 are unlikely to do so again.

European equity markets continue to look attractive and there are finally tangible signs that the region is experiencing broad-based economic growth that looks set to continue over the medium term.

The ECB is also likely to be one of the last central banks to increase interest rates, providing an attractive backdrop for investors.

Finally, investors should prepare for the cryptocurrency craze to implode over the next 12 months, adding to recent losses for traders of bitcoin.

Beyond the direct impact for owners of crypto assets, the wider negative ramifications for technology companies, particularly semiconductor manufacturers, which have exposure to the craze, will be materially negative.

  • David Holohan is chief investment officer at Merrion Private

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