SOC GEN: Why European markets won't repeat Japan's 'lost decades'

Franco Origlia/Getty Images

While they may be under pressure right now because of the threat of a possible Greek debt default, there are many reasons to remain optimistic on the outlook for European equities in the second half of 2015.

So says Societe Generale’s cross asset research team who, in a note released overnight, provide three reasons why they remain bullish on European markets.

  • That Eurozone stocks are unlikely to repeat the “lost decades” experienced by Japanese markets in the 1990s and 2000s;
  • Sustainability of the current consumer-driven recovery and;
  • The likelihood, albeit still in the balance, that there will be a last minute debt deal for Greece

Here’s the basis for the Soc Gen call.

Eurozone stocks avoid a repeat of Japan’s lost decades

“Last year, concerns over a deflationary spiral in the eurozone rekindled fears of a ‘Japanification’ of the region that would lead to a sustained period of poor equity returns. The eurozone is experiencing similar structural challenges as Japan, including unfavourable demographics, still high debt overhang, and lower potential growth. However, eurozone corporates face fewer headwinds than Japanese companies did during the lost decades. In particular, they are less leveraged, while their profitability has remained resilient. As a result, we don’t expect eurozone equities to suffer from a Japanese-style bear market in the future”.

The chart below shows the historic return on equity for US, Eurozone and Japanese listed firms.

Consumption recovery supports earnings

“Given the strong expansion of multiples (albeit from low levels) since mid-2012, eurozone equity markets cannot be considered cheap overall. ECB QE drove P/Es higher, putting the onus on EPS growth to drive future returns. But, after the recent correction, we believe valuations have become more attractive. Price-to-book ratios have fallen back to their levels of early 2014. The combination of positive factors including lower oil, a slower pace of fiscal consolidation, and easier financial conditions should sustain the current consumer-driven recovery, although momentum is unlikely to accelerate further. We thus expect companies’ revenues to continue growing in the coming quarters, supporting further earnings growth”.

And, finally, the question on every market participants mind at present

A last-minute resolution is found to the Greek debt crisis.

Our economists’ base-case scenario (60% probability) remains that a last-minute deal will be struck, leading to a semi-stable scenario, but most likely not before the EU Summit on 25-26 June. That still leaves a 40% risk of Greek default, and possibly Grexit. As a result, eurozone assets could continue to suffer from higher volatility in the coming weeks.

While there are other factors out there that could provide support for Eurozone equities – increasingly divergent monetary policy differentials between the ECB and US Federal Reserve being the most obvious – should a Greek debt deal be reached, Soc Gen “maintain a positive stance on Eurozone periphery markets and expect equities to to rebound from H2”.

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