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08.10.2015 | 15:02

Pictet: Japan and Europe offer best prospects

Valuations and corporate profit forecasts are two of the reasons why Luca Paolini, Chief Strategist Pictet Asset Management, is favouring European and Japanese equities.

“European and Japanese equities remain our favoured markets, partly on valuation grounds but also because corporate profits appear set to grow faster in these regions than in other areas of the world.

“European stocks look particularly attractive. Company earnings are currently rising at an annualised rate in the low single digits but the pace could quicken for a number of reasons. The first is a supportive central bank. The ECB’s ultra-loose monetary policy has translated into a burst of consumer spending, shielding the region’s companies from China’s slowdown and helping the euro zone economy grow for nine quarters in a row”.

“Also helping corporate Europe is the combination of a weak euro and low oil prices, which should have a positive effect on profit margins. Corporate profit margins in Europe are more or less in line with the long-term average which, when seen in the light of a recovering economy, suggests there is plenty of scope for them to expand. This is in contrast with the situation in the US, where margins are at record levels. Overall, our model suggests that continental European corporate profits should rise at about 10 per cent over the next 12 months, led by financial companies”.

“Valuations for European stocks also look reasonable. On measures such as price-earnings and price-to-book ratios, European equities trade at a 10 per cent discount to both their US and global counterparts.

“Japanese stocks are another bright spot. Much like their European peers, Japanese companies have benefited from a currency-fuelled improvement in their global competitiveness, and a weak yen should continue to be a feature of the financial landscape given the Bank of Japan’s ultra-loose monetary policy. At the same time, thanks to improvements in corporate governance, companies are making more efficient use of their balance sheets, which holds out the prospect for a steady increase in the market’s return on equity. Corporate profit margins are also on the rise. None of these developments appear to be reflected in the valuations for Japanese stocks which, on a price-earnings basis, trade at an 8 per cent discount to the MSCI World Index”.

“For emerging markets, however, indicators remain weak; a severe slowdown appears to be taking hold in many key economies. Still, there are signs of stabilisation. While China is grappling with a decline in external demand and the need to pare back public investment, industrial production, construction and consumption are heading in the right direction. China’s purchasing manager’s index rose last month – the first time it has registered a monthly increase since March”.

“This modest rebound could gather more momentum if emerging market central banks follow the example set by India and Taiwan, which cut rates to shore up growth”.
“In response, we have become a little less pessimistic on the outlook for emerging market (EM) equity, and upgrade the asset class to neutral from underweight. Investors have cut back their holdings in EM stocks to such an extent that the scope for a further fall in the market now appears limited. True, corporate earnings prospects are uncertain, and will remain so until the Chinese economy finds a more stable footing. Yet we believe the market correction looks to have gone too far, and expect to see investors rebuild positions soon.”

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