Upgrading European stocks; downgrading emerging market debt

Richard explains why we are upgrading European equities to overweight and downgrading emerging market debt to neutral over the short term.

This week’s chart helps explain why we are upgrading our view of European equities to overweight from neutral. We see European stocks as big beneficiaries of the broadening global reflationary environment and believe investors are too skeptical of the region’s prospects.

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Analysts repeatedly slashed their European earnings growth forecasts in recent years as early optimism faded. Yet 2017 appears different, with upgrades following a late 2016 upward trend, as evident in the chart above. Projected earnings growth is now mostly coming from cyclical sectors that benefit from improving global growth and a weaker euro.

A brighter outlook

The outlook is brighter. Our BlackRock GPS gauges show the U.S.-led bout of inflation leading to stronger growth outlooks globally. Recent upside surprises in European growth and inflation confirm the positive GPS signals. We believe European equities should benefit in such a reflation scenario, absent any other shocks. European earnings have historically been more sensitive to global economy pickups than U.S. counterparts, given European firms’ lower margins and large revenue exposure to global and emerging markets (EMs), our analysis shows.

Yet economic and political shocks have kept investors overly cautious toward European equities in our view. We believe the political risk priced into European markets around upcoming French and German elections is overstated. A likely Italian election may prove to be a populist flashpoint, but the major risk to our view is that a global slump cuts short the reflation trend. Our GPS data imply this is an unlikely scenario in the near term.

Meanwhile, we have cut our views of EM debt and Asian fixed income to neutral from overweight. We see long-term opportunities in EM bonds, but higher valuations make us more balanced in the shorter term. We remain positive on EM equities, where valuations are not a constraint, and favor European stocks exposed to global cyclicality and EMs. Read more market insights in my Weekly Commentary.

Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog.

Investing involves risks, including possible loss of principal.

International investing involves special risks including, but not limited to currency fluctuations, illiquidity and volatility. These risks may be heightened for investments in emerging markets. Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of February 2017 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

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