Is Europe’s economic expansion about to gain momentum? Economists with the European Commission say yes. Earlier this month they raised their forecast for real gross domestic product growth across the euro zone from 1.1 percent to 1.3 percent this year and from 1.7 percent to 1.9 percent in 2016, citing lower oil prices and a weaker euro, among other factors.
Many analysts and research directors who cover the region think those economists aren’t optimistic enough.
“We agree with the increasingly more constructive outlook on euro zone growth,” says Christian Kern, head of European equity research at J.P. Morgan Cazenove in London. His firm is calling for 1.5 percent higher output this year and 2.2 percent more in 2016. “In addition to lower commodities prices and the tailwind from euro depreciation, we highlight easing credit conditions, the smaller fiscal drag than in prior years and the European Central Bank’s quantitative easing,” he notes.
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“The decline in the euro exchange rate has been considerable, and even in euro terms the drop in oil prices has been large,” adds Deutsche Bank’s Mark Wall. “It would be disappointing if the combination did not perk up growth.”
Money managers around the world hope to profit from the region’s improving outlook, and many will look to the sell side for direction on the best places to invest. The firm whose analysts provide the most highly valued commentary is UBS, which vaults from fifth place to first on Institutional Investor’s All-Europe Research Team, seizing top honors for the first time since 2010. The Swiss bank captures 30 positions, a whopping 50 percent increase over its 2014 total and two more than the firms that share the second tier, Deutsche Bank and J.P. Morgan Cazenove. The former’s rank and total are unchanged from last year, while the latter picks up one spot and in so doing advances one level.
However, when a weighting of 4 is applied to each first-place position, 3 to each second-place spot, and so on, BofA Merrill and Deutsche Bank rank highest, each with a weighted score of 62, while UBS comes in third, with a score of 61. (See Weighting the Results.)
Survey results reflect the opinions of 2,040 money managers at 775 institutions overseeing an estimated $6.2 trillion in European equities.
This year marks the 30th anniversary of the ranking. To honor the occasion, II aggregated the survey data for the past three decades to determine which firms and team leaders have racked up the most appearances over that period. The Zurich-based banking behemoth is far out in front, having amassed a stunning 1,345 spots since 1986. In second place overall, with 784 spots, is BofA Merrill, followed in third by Credit Suisse, with 724. Click here for more information about the 30th anniversary rankings.
One of the most honored analysts in the history of the survey, Mark Stockdale, is also the person who oversaw UBS’s return to the top of the roster. Stockdale and the squads he’s directed garnered 24 appearances in Building & Construction — including nine visits to the winner’s circle — from 1989 (when he was with Barclays de Zoete Wedd; he joined UBS predecessor S.G. Warburg in 1992) through 2011, when he was promoted to head of European equity research. He held that post until last September (just as polling for the current survey got under way), then moved into the bank’s corporate broking division. His successor in the research role is Daniel Dowd, former director of U.S. equity research at Sanford C. Bernstein & Co. in New York.
UBS declined to make either Stockdale or Dowd available for interview.
J.P. Morgan Cazenove has also undergone a change at the top of its European equity research ranks. Kern replaces Paul Huxford, who retired in October.
“The current market rally in Europe has legs to it, as the quantitative easing program is coinciding with improving activity data flow,” declares Kern, who has appeared on the All-Europe Research Team as leader or co-leader five times since 2001; this year he manages a squad that earns a runner-up position for coverage of the United Kingdom. “At the global level we believe that in 2015 the euro area will outperform the U.S. Within the euro zone our top pick for the past few months was Germany, but we increasingly think that the periphery needs to catch up.”
His crew remains underweight on U.K. stocks, in part owing to political uncertainty. “We see the U.K. elections in May as important,” he says. “Depending on the election outcome, a potential referendum with regard to the U.K.’s European Union membership could follow.”
Jonathan Jayarajan, Deutsche Bank’s deputy head of Europe, Middle East and Africa equity research, agrees. “The U.K. election could potentially have some profound implications if a center-right government led by the Conservatives comes to power,” he says. “The Conservatives have promised a referendum on the U.K.’s membership of the EU, which would likely be accelerated if they are in coalition with the U.K. Independence Party.”
Jayarajan, who is based in London, believes the contest will be close. “If the U.K. were to vote to leave, that would clearly have a profound impact on both the U.K. and the EU,” he adds.
Threats to regional cohesion aren’t coming only from the right wing. In Greece the far-left Syriza party rode to victory in January on an anti-austerity platform that puts the deeply indebted nation on a collision course with its European creditors.
Richard Smith, Deutsche Bank’s London-based joint global head of equity research, is confident the two sides will be able to resolve their differences.
“Despite the apparent polarization in the views of the new Greek government and its European partners, we believe it is in their collective best interests to find a compromise that allows Greece to remain within the euro zone — but with greater breathing space than it has today,” he says. “As we approach the point when funding for Greek banks starts to run out or when the Greek government runs short of funds, we believe the serious negotiations will begin.”
Kern shares that view. “The negotiations are likely to get worse before they get better, and near-term volatility will remain elevated, but we believe a compromise will be reached in the end,” he says.
Political instability is hardly limited to the euro zone. “At the moment, the Russia-Ukraine crisis remains the one most likely to have more global implications if peace negotiations are unsuccessful,” observes Jayarajan. “A flare-up in the region will raise tensions between Russia and the West and will likely see further economic impact. We do not expect a full-scale military conflict between Russia and the West, but a proxy war remains a significant risk.”
Something similar is already under way in the Middle East, according to Christyan Malek, who leads the Nomura International team to victory in the Oil Services sector. “The cold war between Iran and Saudi Arabia is the primary driver of the Saudis’ willingness to tolerate lower-for-longer oil prices,” he explains. “The kingdom arguably uses low oil prices to eliminate the threat of Iran and ultimately force the country into a regime change” or a treaty that sharply reduces its influence in the so-called Shia belt that includes Bahrain, Iraq, Syria and Yemen.
“This remains a key and recurring theme from our trips to the Middle East and is the primary basis of why we have been cautious on oil prices since April of last year,” adds Malek, who works out of London.
He and his associates are urging clients to avoid Europe’s oil field services providers at all costs. “Any sector rally led by a rebound in oil prices and/or positive earnings-per-share surprises should be seen as temporary — and an opportunity to sell,” he contends. “We think company management teams might be lured into a false sense of security as they are able to ‘dine off’ legacy backlogs — secured at healthy margins — to help offset losses in [earnings before interest and taxes] resulting from reduced pricing and lower asset utilizations.”
Such good times won’t last, however. “Derating of backlogs and collapse in margins are inevitable,” he insists, and likely to occur in the next 12 to 18 months.
One sector that usually benefits from heightened geopolitical uncertainty is aerospace and defense. “We are recommending exposure to European defense names as global tensions rise in Europe, Asia and the Middle East,” reports Céline Fornaro, who guides her BofA Merrill crew in London back to the top of the sector roster, after two years in second place. “In Europe some countries have delayed their defense budgets cuts — Sweden, U.K., France, Poland and Finland — and are reverting to growth after years of declines. The U.S., through its fiscal 2016 budget, is signaling a healthy return to growth in equipment spending for defense. Other allies, such as Japan and Australia, have increased their fiscal 2015 defense budgets.”
In these uncertain times being prepared is a lesson that also applies to investors — especially those that believe the central bank’s bond-buying scheme will be the cure to what’s ailing Europe.
“The ECB is not in full control of the situation,” cautions Wall, who shepherds the Deutsche squad to its fourth straight appearance at No. 1 in Economics. “Much still depends on the health of the global economy, the actions of other central banks and whether Europe implements structural reforms.” Nonetheless, the London-based economist adds, “we can afford to be more optimistic.”