Bad News Is Good News for Eurozone Stocks
In early 2016, few investors were willing to consider contrarian arguments about why Eurozone stocks were attractive. Those arguments included depressed valuations, bearish sentiment, and disappointing macro data. At the time, the general disdain toward European equities was understandable, given that they fell 2.8% in 2015, underperforming U.S. and global equities.1

In hindsight, which is always 20/20, we know that both the MSCI Europe and Euro indices bottomed—alongside Eurozone economic surprises—in the first quarter of 2016 and rose 25.5% in 2017, significantly outperforming U.S. and worldwide stocks.2

While many investors are self-proclaimed contrarians, the early-2016 experience with European equities reminds us just how difficult it is to zig when others are zagging. Fortunately, a similar opportunity to ignore the seemingly bad news and consider investing in Eurozone stocks presented itself in the first quarter of 2018 and remains wide open, in our view.

Specifically, Eurozone economic surprises fell below -1 standard deviation from the mean on March 22, 2018, a rare yet typically profitable event. At present, the surprises are the worst they’ve been since 2011 (Exhibit 1).

Exhibit 1: Eurozone Economic Surprises Are the Worst Theyve Been Sinze 2011

How rare and profitable are these episodes? First, such -1 standard deviation events have occurred just 19 times, or 0.5% of the time, since 2003. That’s unusual to us.

Second, forward returns on the MSCI Euro Index were superior after each occasion when the Citigroup Economic Surprise Index (CESI) for the Eurozone fell below -1 standard deviation from the mean. Since 2003, excluding the March 22, 2018 episode, the median 12-month forward return was a whopping 17%, compared with a compound annual growth rate of only 6.6%, for an excess return of 10.4%.3

Third, this contrarian strategy had a success rate of 89%, meaning it produced positive returns in 16 of the 18 times it was triggered across a timespan that includes a global financial crisis and a double-dip European recession. In our view, that seems like a pretty reliable strategy (Exhibit 2).

Exhibit 2: Extremely Negative Economic Surprises Are Bullish Contrarian Signals for Stocks

The Bottom Line

After a stellar 2017, European equities had a challenging start to 2018. However, we believe that the fundamental thesis hasn’t changed and short-term weakness will ultimately prove to be a long-term buying opportunity.

Indeed, the MSCI Euro Index is up 7.2% since March 22, 2018, or when the Eurozone CESI fell below -1 standard deviation from the mean.4

Looking ahead, we expect European equities to continue outperforming, given attractive valuations, subdued inflation, supportive monetary policy, solid economic and earnings growth, and cumulative investor inflows.

  1. ^Source: Bloomberg, net total returns in U.S. dollars, 12/31/15.
  2. ^Source: Bloomberg, net total returns in U.S. dollars, 12/31/17.
  3. ^Source: Bloomberg, net total returns in euros, 5/11/18
  4. ^Source: Bloomberg, net total returns in euros, 5/11/18

The MSCI Europe Index captures large- and mid-cap equities across 15 developed market countries in Europe, including Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the UK.

The MSCI Euro Index captures large-cap equities across the 10 developed market countries in the European Economic and Monetary Union, including Austria, Belgium, Finland, France, Germany, Ireland, Italy, the Netherlands, Portugal and Spain.

The Citi Economic Surprise Indices measure data surprises relative to market expectations. A positive reading means that data releases have been stronger than expected, and a negative reading means that data releases have been worse than expected.

The indexes are unmanaged, include the reinvestment of dividends and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict performance of the Fund. Past performance does not guarantee future results.

Standard deviation measures the dispersion of a data set from its mean or average. If the data points are further from the mean, the standard deviation is higher. If the data are closer to the mean, the standard deviation is lower.