The Equity Rally Has Room to Run | The Silver Screen

Dow Jones Global Indexes | Global Stock Markets

Even after the strongest first-quarter rally since 2006, European equities offer good value. The Europe Stoxx 600 index gained 7.7% in the January-March stretch, the best showing since a 7.9% rise in the opening quarter of 2006. And that’s despite losing 263.32 points, or 0.9%, Friday.

Granted, the Continent’s stocks underperformed the Standard & Poor’s 500, which shot up 12% in the quarter. But there looks to be more room to run. The Stoxx Europe 600 trades for 14.4 times trailing 12-month earnings, compared with 16.2 times for the S&P. Plus, the Europe Stoxx constituents offer a dividend yield of 3.4%, against a yield of 2% for companies in the S&P.

The performance of the Stoxx 600 was led in the latest quarter by the technology sector, which gained 14.3%. Among tech constituents, Logica (ticker: Log.U.K.) soared 62%, while Capgemini (CAP.France) rose 39%. Automobiles and parts was the best-performing sub-sector, up 25%, boosted by a near-50% gain in Renault (RNO.France).

Financials were up 13%, although they relinquished some gains in March. Still, Belgian bank KBC Group (KBC.Belgium) rose 93%, and France’s Natixis (KN.France), 48%.

The backdrop could darken in the second quarter, given political and economic turmoil, but investment opportunities remain. Morgan Stanley’s European equity team favors companies with pricing power, whose shares could outperform in a weak economy. The firm’s European analysts see rising pricing power in chemicals, hotels, luxury goods, oil services, software, tobacco and land-based transportation concerns. Pricing power is falling, they say, in autos, capital goods, medical technology, mining, pharmaceuticals, security and air transport.

Macquarie recommends playing the market rally from here through “real economy cyclicals,” which include metals and mining shares, energy, capital goods and tech. Valuations are still reasonable, the firm wrote recently, and these industries historically have driven rallies at this stage in market cycles. The equities-research team counsels underweighting financials, which typically underperform at this point in a rally, as do defensive sectors such as utilities and health care.

THE EURO ZONE BOUGHT ITSELF TIME with the latest bailout of Greece and an injection of liquidity into European banks by the European Central Bank. But borrowing costs are climbing again in Portugal, Italy, and Spain, indicating fears about the Continent’s financial stability merely have shifted. Finance ministers agreed Friday to boost the euro-zone bailout lending limit temporarily to 700 billion euros ($933 billion) from a prior €500 billion, although skeptics say the higher amount is insufficient, too.

Politics is complicating Europe’s path to recovery even more than usual these days. Euro-zone members need to approve the fiscal compact in the months ahead. In addition, voters in France go to the polls April 22, with President Nicolas Sarkozy, a staunch supporter of European union, facing an uphill battle against the Socialists, who are pushing for more stimulus measures to accompany austerity demands.

Greece appears set for elections in May, and the parties likely to form a coalition government share little ground, which could lead to more instability. Spain’s government, meanwhile, is facing mounting opposition to austerity measures as it tries to grapple with the country’s budget deficit. The country’s current leaders, in office just a few months, are trying to close the deficit in one dramatic step rather than through incremental measures. Italy is struggling with labor-market reform amid opposition.

Equity investors can expect significant volatility, says Virginie Maisonneuve, head of international equities at Schroders Investment Management in London. Yet, that’s not a bad thing. “It is an opportunity to accumulate [shares] because 2013 looks like an OK year,” she says, following the current “year of normalization.”

Maisonneuve likes companies with strong balance sheets, brands and growth prospects, including Schneider Electric (SU.France), Roche Holding (ROG.Switzerland), Diageo (DEO), BG (BG.U.K.) and SAP (SAP). Schroders owns shares of each, and Maisonneuve says she’ll add to these positions if the shares weaken. 

Downer

Spanish and Italian stocks fell sharply last week, as Europe’s major indexes lost ground.

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