1. Art and Diseño

28 January 2015
CIO WM Research
European equities
Eurozone comeback
• Leading economic indicators have troughed and are signaling a
tentative near-term pickup in eurozone economic growth. In our
view, both economic growth and inflation will improve over the
course of 2015.
• The weaker euro will provide a tailwind for eurozone corporate
earnings, which are far below their pre-crisis levels.
• The European Central Bank's decision to ease monetary policy
further by purchasing sovereign bonds provides an additional
support factor for the market.
• We expect eurozone equities to outperform our non-US
developed market benchmark (EAFE) over the next 6 months on
a currency-hedged basis.
Brian Rose, Sr. Investment Strategist, UBS FS
[email protected], +1 212 713 3671
Fig. 1: GDP still below pre-crisis peak
Real GDP index, seasonally adjusted
106
104
102
Eurozone corporate profit rebound to begin
100
98
The unique economic structure of the eurozone, with its shared
currency, vulnerable peripheral members, and heavy reliance on bank
lending for corporate finance, has made it difficult to generate a
sustained recovery following the global financial crisis. As shownin
Fig. 1, seven years after the onset of the crisis, eurozone GDP remains
below its pre-crisis peak. Under these circumstances it is not surprising
that eurozone corporate earnings remain depressed. However, we
now believe that a sustainable recovery is starting to take hold,
and with a weaker euro providing a tailwind for corporate earnings,
eurozone equities appear attractive relative to other international
markets.
96
94
92
90
2004
2006
2008
2010
2012
2014
Source: European Central Bank, as of 3Q 2014
ECB finally implements full-blown QE
Headline inflation in the Eurozone fell into negative territory in
December. With inflation below target and inflation expectations
declining, the European Central Bank (ECB) finally decided to pull
the trigger on full-blown quantitative easing, including sovereign
bond purchases. Having already introduced negative deposit rates
and a variety of other monetary stimulus measures, the ECB will now
purchase EUR 60bn of private and public assets a month at least
through September 2016. It intends to expand its balance sheet from
EUR 2trn to about EUR 3trn, which should help to keep downward
pressure on the euro in foreign exchange markets.
This report has been prepared by UBS Financial Services Inc. (UBS FS). Please see important disclaimers and disclosures
that begin on page 3.
European equities
Economy starting to improve
Ironically, the ECB's decision came against a backdrop of improving
economic data. Leading indicators have troughed and are signaling a
tentative near-term pickup in eurozone economic growth. For example, the German Ifo, historically a lead indicator for eurozone equities,
has turned and is pointing to a positive outlook among German purchasing managers. While the negative inflation data spurred the ECB
into action, deflationary pressure is coming mainly from lower prices
for oil and other commodities. Eurozone equities are actually net beneficiaries from a lower oil price. The energy sector represents only
5% of the equity market, while consumer staples and discretionary
combined are about 25%. In our view, despite the recent downtrend
in prices, both economic growth and inflation will improve over the
course of 2015.
Earnings outlook positive
The ECB's actions combined should amplify key drivers of our positive
stance towards Eurozone equities: the depreciation of the euro and
low refinancing costs for companies. The exchange rate turned into
a year-over-year tailwind for earnings in the fourth quarter of 2014,
and the euro has weakened further in 2015. We expect companies
therefore to report a positive earnings impact from translational currency effects in the upcoming earnings season and into 2015 overall.
As shown in Fig. 3, eurozone corporate earnings are far below their
pre-crisis peak. With support from an economic recovery and a weaker euro, we see great potential for earnings to grow at a robust pace
in the years ahead.
Recommend hedging currency, but only in the short term
On a 6-month time horizon we would recommend that dollar-based
investors hedge the currency exposure on their euro assets. However,
in our view the euro is far below its equilibrium value against the dollar. For investors intending to maintain a position in eurozone equities
for a year or more, leaving the currency exposure unhedged may be
the better option.
Fig. 2: Euro weakness will help earnings
EUR/USD exchange rate
1.70
1.60
1.50
1.40
1.30
1.20
1.10
1.00
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Source: Factset, as of 26 January 2015
Fig. 3: Earnings have potential to rebound from
depressed levels
Eurozone 12-month trailing earnings per share
25
20
15
10
5
0
2006
2008
2010
2012
2014
Source: Datastream, as of 22 January 2015
Germany a bastion of strength
Relative to the rest of the eurozone, Germany has enjoyed better economic conditions and corporate earnings. While it does not have the
same potential for earnings to rebound off of depressed levels, we still
expect double-digit earnings growth in 2015 and 2016. The German
market has historically traded at a valuation premium (i.e., a higher
price-earnings ratio) to the eurozone, but currently trades at a discount. One attractive way to invest in eurozone equities is therefore
through a fund concentrating on Germany. See our publication German Equities: Attractive fundamentals at a discount, for details.
Greek politics unlikely to derail recovery
With the far-left party Syriza earning the most votes in the recent
Greek national elections, there is heightened uncertainty regarding
the new government's willingness to abide by previous agreements
with the Troika. While eurozone equities face headline risk regarding
Greece, we believe that an agreement will eventually be reached that
will avoid significant damage to eurozone recovery prospects.
UBS CIO WM Research 28 January 2015
2
European equities
Appendix
Terms and Abbreviations
Term / Abbreviation
Description / Definition
Term / Abbreviation
Description / Definition
1Q, 2Q, etc. or 1Q11,
2Q11, etc.
E
UP
First quarter, second quarter, etc. or first quarter
2011, second quarter 2011, etc.
expected i.e. 2011E
Underperform: The stock is expected to
underperform the sector benchmark
UBS Chief Investment Office
A
actual i.e. 2010A
GDP
WMR
Gross domestic product
UBS Wealth Management Research
CIO
UBS CIO WM Research 28 January 2015
3
European equities
Appendix
Global Disclaimer
Chief Investment Office (CIO) Wealth Management (WM) Research is published by UBS Wealth Management and UBS Wealth Management
Americas, Business Divisions of UBS AG (UBS) or an affiliate thereof. CIO WM Research reports published outside the US are branded as Chief
Investment Office WM. In certain countries UBS AG is referred to as UBS SA. This publication is for your information only and is not intended as
an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. The analysis contained herein does not constitute
a personal recommendation or take into account the particular investment objectives, investment strategies, financial situation and needs of
any specific recipient. It is based on numerous assumptions. Different assumptions could result in materially different results. We recommend
that you obtain financial and/or tax advice as to the implications (including tax) of investing in the manner described or in any of the products
mentioned herein. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/
or may not be eligible for sale to all investors. All information and opinions expressed in this document were obtained from sources believed
to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or completeness (other than
disclosures relating to UBS and its affiliates). All information and opinions as well as any prices indicated are current only as of the date of this
report, and are subject to change without notice. Opinions expressed herein may differ or be contrary to those expressed by other business
areas or divisions of UBS as a result of using different assumptions and/or criteria. At any time, investment decisions (including whether to buy,
sell or hold securities) made by UBS AG, its affiliates, subsidiaries and employees may differ from or be contrary to the opinions expressed in
UBS research publications. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing
the investment and identifying the risk to which you are exposed may be difficult to quantify. UBS relies on information barriers to control
the flow of information contained in one or more areas within UBS, into other areas, units, divisions or affiliates of UBS. Futures and options
trading is considered risky. Past performance of an investment is no guarantee for its future performance. Some investments may be subject to
sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in FX
rates may have an adverse effect on the price, value or income of an investment. This report is for distribution only under such circumstances
as may be permitted by applicable law.
Distributed to US persons by UBS Financial Services Inc., a subsidiary of UBS AG. UBS Securities LLC is a subsidiary of UBS AG and an affiliate
of UBS Financial Services Inc. UBS Financial Services Inc. accepts responsibility for the content of a report prepared by a non-US affiliate when
it distributes reports to US persons. All transactions by a US person in the securities mentioned in this report should be effected through a
US-registered broker dealer affiliated with UBS, and not through a non-US affiliate. The contents of this report have not been and will not be
approved by any securities or investment authority in the United States or elsewhere.
UBS specifically prohibits the redistribution or reproduction of this material in whole or in part without the prior written permission of UBS and
UBS accepts no liability whatsoever for the actions of third parties in this respect.
Version as per May 2014.
© UBS 2015. The key symbol and UBS are among the registered and unregisteredtrademarks of UBS. All rights reserved.
UBS CIO WM Research 28 January 2015
4