European economy remains promising despite war, inflation

Despite war, inflation, and evolving energy supply dynamics, Europe remains a hotspot for investment, says David Brown, an investment specialist with J.P. Morgan in New York.

Brown, who works on the firm’s multi-asset solutions team, said eurozone equities are attractive from a relative value perspective.

“If I had to pick a region where we have the most conviction, I would say it’s the eurozone,” he said. “That’s an area where you see a resiliency in terms of the overall economy, both from the corporate and the financial base.”

He said Europe has battled low expectations due to the protracted Russia/Ukraine war, ongoing concern over energy supply, and negative market sentiment for the past 18 months. Yet equities have performed relatively well.

“Frankly, the economy has surprised to the upside,” he said. “It is outperforming the U.S., in terms of economic activity.”

Brown pointed to purchasing managers’ index (PMI) data for April, which showed a eurozone composite PMI score of 54.1, an 11-month high. That compares to a composite PMI score of 53.4 for the U.S. in the same period. According to S&P Global, a PMI score above 50 indicates economic expansion.

Brown said he’s looking to take advantage of “markets outside the U.S. that are cheaper in terms of valuation and have the benefit of higher level of growth compared to the U.S.,” with the eurozone being the most direct example.

Equities

Brown said the most recent quarterly earnings, globally, are bearing out analyst expectations of declining revenues. Forward projections are being modified downward.

“That being said, I think corporates have definitely taken the opportunity to tighten their belts,” he said. “And so, while there’s been decline in corporate earnings overall, it has not been a disappointing earnings season. Low growth doesn’t mean no growth.”

While he prefers non-U.S. developed markets, he’s still holding some U.S. large cap for their defensive characteristics. He’s not sold on small-cap equities.

“The weakness that we are seeing in the U.S. is going to most directly impact small-cap equities.”

Fixed income

On the fixed-income side, he prefers shorter-maturity investment-grade bonds over high yield. Not only is there good carry in investment grade, but it is more insulated from general economic weakness, he said.

He’s also looking at the sovereign bond market.

“I would say it has dual benefit. One, it’s providing ballast to the equity risk that we hold, offsetting some of those more-volatile days,” he said. “And then, the other part of it is you’re getting a positive yield, which for years, post-[great financial crisis], was not the case. Yields were so low that it was really hard to find carry.”

Now he finds abundant carry both within and outside of the U.S.

“We’re using a blend of U.S. treasuries and non-U.S. government debt. Namely, we like [Japan government bonds] and German bunds,” he said. “And then, in terms of where we’re positioning on the curve, we’re kind of barbelling it, taking advantage of the long end as well as the short end.”

Brown said he expects the yield curve to steepen over time.

“We hope to benefit from that with our longer treasury positions,” he said.

It all boils down to watching the numbers very carefully.

“My key takeaway would be proceed with caution and pay attention to the data in looking for opportunities,” he said.

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.