As the dust settles after of the most dramatic weeks for global markets since the financial crisis, attractive valuations and high yields in European equities suggest that a recent rebound has further to go. Some strategists are downgrading earnings forecasts, but euro zone stocks with domestic exposure are expected to hold up relatively well.
Financial services and telecoms and pharmaceutical companies that pay hefty dividends are likely to benefit the most after the sell-off. The hardest-hit stocks, such as mining companies, are recommended only for the brave. Valuations have dropped back towards their lows for the year, while the relatively attractive yield of equities compared with is still near its highest since the crisis.
"If you look at the arguments for European equities, they still stand up to scrutiny," said Neil Wilkinson, European equity fund manager at Royal London Asset Management. Although price-to-earnings ratios have rallied since their lows in 2011, the recent weakness has lowered valuations towards levels not seen since the start of the year. The FTSEurofirst 300 recovered losses made earlier in the week, but it is still set for its biggest monthly decline since 2012.
"This correction in the near term ... has been overdone, and therefore we are still looking at the opportunity to be buying back into equities at better value," said Oliver Wallin, the investment director at Octopus. Mining shares have recovered along with the price of copper. But China has "clearly meaningful problems which are not going to disappear soon," analysts at Citi said, so that trade was "too brave for us", even if companies with strong balance sheets such as Glencore and BHP Billiton weathered the worst of the storm.
For the more cautious, dividend-paying stocks are back in vogue. One effect of the turmoil has been to push back predictions of a Fed rate increase, and lower rates make such shares more attractive. UBS notes the payouts that European companies offer, with the gap between dividend yields and real Bund yields still near its crisis high. European dividend yields also still exceed US dividend yields, as well as corporate and government bonds.
Citi highlights the likes of AstraZeneca, Munich Re and Novartis as healthy dividend payers that can withstand the worst of market volatility. However, some dividend payers have suffered in the recent sell-off. RLAM's Wilkinson used the recent market fall as an opportunity to build positions in Deutsche Telekom and ING, which are set to pay attractive dividends over the coming years.
Both stocks at one point were down around 20 percent in August, but both have bounced over 10 since lows hit on Monday, helped by bets that the Fed will keep interest rates low for longer. Another appeal of the stocks is that most of their business is exposed to Europe and the United States, not China. While earnings estimates for commodity-exposed stocks have fallen sharply as concerns over China have built up, UBS found that earnings estimates for euro zone companies have held steady, with analysts expecting over 10 percent earnings growth.
Many exporters that benefit from a weak euro are sensitive to a decline in Chinese demand, but some see potential for a rebound in domestic consumption. "The focus here should be on the European consumer stocks looking forward into 2016 and '17, because it's clear that the European consumer is going to be driving this forward," said Michael Browne, fund manager at Martin Currie.
After a Monday session that saw European shares post their biggest loss since Lehman Brothers collapsed in 2008, many were braced for continued market chaos. However fund managers say that the situation is different to 2008, when the market remained under pressure for months afterwards. "When I came back to the office, there were stocks that had fallen around 20 percent in the market turmoil," said RLAM's Wilkinson, who returned from holiday at the start of the week. "Stocks had been hit badly that didn't deserve to be penalised... Even with the concerns over global growth, there are still opportunities in European equities."
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