Mario Draghi's "whatever it takes" pledge to resuscitate the moribund European economy appears to be working. The European Central Bank's (ECB) aggressive monetary easing policy has so far succeeded in stimulating lending, boosting exports and gently lifting sentiment. Those measures, together with cheaper energy prices, recently drove the region's services and manufacturing output to four-year highs.
This brightening backdrop has steadily trickled into equity markets, with the MSCI Europe index rising 5 per cent over the past year. That was achieved despite a couple of notable setbacks, led by weak summer data from China and a disappointed reaction to recent news that the bloc's heads won't yet ramp up their bond buying programme.
But while Mr Draghi's tinkering may have irked traders anticipating a more aggressive approach, his decision to cut interest rates to all-time lows and expand the dimensions of the €60bn (£43m) a month quantitative easing package until March 2017 shouldn't be underestimated. Slashing the deposit rate by 10 basis points to minus 0.3 per cent makes it even more profitable for banks to offer loans to consumers and businesses, while the extension of the ECB's money-printing efforts is expected to further buoy growth and drive higher inflation.
According to the many economists and fund managers scouring the region, these policies once again make Europe the ideal stock market destination for the year ahead. Overweighting the continent has emerged as a prominent feature across asset allocation dossiers, driven by the belief that months of turmoil have left markets failing to price in the region's recovery potential.
More than a cut and paste job
Despite sluggish growth elsewhere threatening to derail this progress, head of European equities at Fidelity Paras Anand expects 2016 to be an even better year. "Economic growth across the eurozone will surprise positively, supported by improvements in consumption as not only employment but, importantly, wage growth improves," he said.
"Clearly, in such a heterogeneous region, this effect will not be uniform. But it will be widely enough felt to impact growth and inflation so it begins to look and feel more like a normal recovery, rather than a permanent slump." Such a scenario prompted analysts at Barclays to predict that earnings will accelerate 15 per cent in 2016, easily surpassing the 4 per cent expected from the US.
Value emerging
With the Federal Reserve poised to lift interest rates, a growing number of analysts now reckon valuations across the pond have peaked. Since 2008 the FTSE Eurofirst 300 has underperformed the S&P 500 by more than 50 per cent in price terms, as concerns over the general economy, the stability of the union and squabbles between Greece and Germany steered investors away from European equities.
But now that the US economic recovery is potentially stuttering, stocks there are starting to look very expensive against their historical averages and discounted European counterparts. That's also raising the argument that value is finally set to eclipse growth as a stock-picking strategy. As value shares tend to outpace in tightening cycles, and are the cheapest they've been relative to their growth counterparts since the technology bubble of 2000, there could be a strong case here.
With the European economy primed to grow, global equity strategists Ian Scott and Dennis Jose at Barclays have started to favour cyclicals over defensives. Based on the assumption that investors are pricing in a worse economic outcome than lead indicators are showing, they've developed a penchant for Belgian chemical company Solvay (BE:SOLB), industrials such as the world's largest courier Deutsche Post (DE:DPW) and global energy specialist Schneider Electric (FR:SU).
They're also backing French behemoth Total (FR:FP) for success, a logic tied to the bank's internal forecasts that the oil price will rebound to $70 (£46m) a barrel by the end of 2016. The likes of AXA (FR:CS), Banco Popular (ES:POP), Intesa Sanpaolo (IT:ISP) and UBI Banca (IT:UBI) are similarly on Mr Scott's and Mr Jose's radar as the region's financial institutions cut costs and benefit from easing regulatory pressures.
We've also gone on a hunt for value on European bourses. Our stock screen, which identifies lowly rated constituents of the S&P Europe 350 index against return on equity, operating cash conversion, operating margin, three-year historic EPS and EPS forecasts for the next two financial years, produced an altogether different list of names. Overall, 14 companies made the cut in at least four of the five measures of quality, although a fair few are plagued by some pretty grotesque problems.
VW scandal creates buying opportunities
European equity markets were gripped during 2015 by news that one of its most respected brands, German car giant Volkswagen (DE:VOW3), defrauded customers by secretly installing software designed to cheat car emission tests. Given the fines and damage inflicted on this once enviable brand, we would steer well clear of its downtrodden shares for now. Nevertheless, investors shouldn't write off the rest of the automotive sector, especially as many of the best car manufacturers' valuations got unfairly caught up in the crossfire.
Daimler (DE:DAI), the automotive giant behind Mercedes-Benz, Maybach and Smart, is perhaps the most attractive name to arise from the stock screen. The Stuttgart-based company's shares have come under pressure from the VW fiasco, creating a welcome buying opportunity in a company that just recently confirmed guidance for a significant rise in operating profit.
Third-quarter profits surged by more than 30 per cent as the group sold a record number of Mercedes-Benz cars and hit new highs in China. Despite sector-wide talk of slowing sales in important emerging nations, Daimler's fresh product line-up of sport utility vehicles proved very popular, helping it to grab market share from rivals BMW (DE:BMW) and Audi. Sceptics may question how long the group's product momentum will last and what impact a decline in US heavy truck sales could have. But a forward PE ratio of 9 times consensus earnings estimates for the next 12 months overplays those concerns, leaving shares trading at an attractive discount to peers.
Renault's (FR:RNO) shares are even cheaper, although complaints about its polluting diesel cars and tepid trading in the six months to June help to explain why. The French automaker, which also holds a 45 per cent stake in Nissan (JP:7201), was forced to sell its ageing model line-up at a discount, with added features to draw buyers in.
Fortunately, 2016 should prove to be more fruitful, thanks to the launch of a plethora of costlier new motors, including the Kadjar and Espace. These arrivals, coupled with management's drive to better utilise Renault's expanding capacity, ought to improve the product mix in the year ahead. But such prospects are perhaps not reflected in shares, which trade at a steep discount to peers such as Peugeot (FR:UG) and Fiat Chrysler (IT:FCA) on 8 times consensus earnings estimates for the next 12 months
Valeo (FR:FR) similarly has the wind in its sails. As a high-quality market leader in emissions-reducing technology, the French parts supplier is tapped in to regulatory trends across the globe. It also has a strong foothold on emerging demand for connected and autonomous cars and has rationalised its cost structure to better handle downturns. Those credentials leave the shares, which trade at a 9 per cent discount to peers, a tempting proposition.
Rise of the discounters
The outlook for tyre manufacturer Michelin (FR:ML) is less convincing. In previous years customers paid up for high-quality tyres, yet Continental (DE:CONX) and Pirelli's (IT:PC) selling of less durable products on the cheap has since won over cash-strapped European hauliers. Management responded by launching a global restructuring programme to boost efficiency. That should eventually help ease the blow of pricing pressures, but for now we think the shares deserve to trade at a 21 per cent discount to the sector's new top dog, Continental.
Another trend sweeping the globe is discount supermarket chains. Distribuidora Internacional de Alimentación (ES:DIA), otherwise known as Spanish international conglomerate Dia, has certainly capitalised on recession-hit locals doing their weekly shop at cheaper outlets. What's more, the group is benefiting as better paid employers spend more as the Spanish economy enters recovery mode.
Management plans to use this momentum, and the extra cash generated, to snap up new stores in a bid to take the fight to market leader Mercadona. But despite some exciting prospects, shares have been marked down heavily to reflect the group's hefty debt pile and exposure to South America.
Like many retailers, Dia now sells its groceries and consumer goods online. This sector-wide shift to accommodate internet shopping has been filling the coffers of the continent's packaging firms. Europe's leading corrugated packaging company, Dublin headquartered Smurfit Kappa (IE:SK3), is particularly well positioned to take advantage of soaring demand for its flexible, sturdy and sustainable cardboard solutions. But despite its excellent operational track record and status as a market leader in a thriving sector, the shares trade at a 20 per cent discount to peers.
Riskier plays
Other names that received top billing in our screen included Swedish mining and smelting company Boliden (SE:BOL), ballbearing maker SFK (STO:SKF-B), Austrian steel specialist Voestalpine (AT:VOE) and Norwegian chemical company Yara International (NO:YAR). Despite each being regarded as quality companies in their fields, sluggish industrial growth and weak commodity prices have weighed on trading.
The screen also featured French giants Electricite de France (FR: EDF) and Publicis Groupe (FR:PUB). In the case of the former, an expensive £18bn project to build two nuclear reactors at Hinkley Point has sparked fears of uncontrollable debt and inevitable dividend cuts - EDF borrows money every year to pay its dividend. Events at Publicis Groupe are equally grim. The multinational advertising and public relations behemoth has struggled since the failed merger with rival Omnicom, as the global slowdown led an unusually large number of clients to downsize and cancel campaigns.
Europe's biggest telecoms names have similarly been mired in problems triggered by external events. While Swisscom (CH:SCMN) has come under fire from increasing competition, Norwegian Telenor (NO:TEL) has been plagued by a deepening corruption investigation into VimpelCom (US:VIP), the Russian telecoms group in which it has a large stake. The company, which is 54 per cent owned by the Norwegian state, just recently suspended its finance director and three other senior figures as part of the probe.
