In its first of three 2013 themes, Macquarie Group sees a positive year ahead for European equities as they continue to react to the quantitative easing that is in place.
QE should be positive for all major asset classes, but there can be lags among those classes which are typically seen as being more cyclical in nature – like equities. So far in Europe, bonds and credit have clearly been the biggest beneficiaries of QE with significant gains in recent years.
However, the reaction from equities as an asset class has been much more limited. Some relatively low-risk equities stocks have begun to react but that is basically all. Macquarie believes this limited reaction can be seen in several ways.
"By our calculations the equity risk premium currently implied for European equities is not hugely dissimilar to that which prevailed at the time that Lehman’s collapsed in late 2008. Yet there has been a pronounced improvement in the economic outlook over that period. Something is wrong,” Macquarie said.
The difference between the earnings yield on European equities versus 10-year German bonds is 7 percentage points, just below its record high of 9 percentage points and very high on a historical basis.
On a dividend yield basis, Macquarie notes that 85 per cent of European stocks are yielding more than the 10-year German bond yield, which is very close to its all-time high of 87 per cent.
Having said all that, the broker believes the 11.8 per cent gain for European stocks last year indicates that the asset class has started to react but there is plenty more upside to come over the coming year or two.
With all this in mind, Macquarie believes the best way to take advantage of this thematic is to focus on European stocks that have a solid dividend yield, earnings that are unlikely to fall and for the stock not to be expensive versus the overall market.