Pictet’s Luca Paolini bets on Japan and Europe

Pictet Asset Management’s chief strategist Luca Paolini is confident European and Japanese equities can deliver despite a wave of uncertainty continuing to cloud global markets.

While investors universally suffered during the recent market volatility, the two regions have managed to keep their heads above water.

Year-to-date the MSCI AC World index is off by 1 per cent after nose-diving during August’s carnage, while in contrast Japan’s Nikkei 225 is up 6 per cent and the MSCI AC Europe is ahead by 2 per cent.

Imminent interest rate rises in the UK and the US continue to rattle investors but both Japan and Europe are currently benefiting from the impact of ultra-loose monetary.

However, Paolini believes this is only part of the story: “European and Japanese equities remain our favoured markets, partly on valuation grounds but also because corporate profits appear set to grow faster in these regions than in other areas of the world.”

Paolini asserts that European stocks look particularly attractive right now. While he admits company earnings across the continent are presently rising at an annualised rate in the low single digits he believes the pace could quicken.

He says that the European Central Bank’s €60bn (£44bn)-a-month quantitative easing policy has translated into a burst of consumer spending, shielding the region’s companies from China’s slowdown and helping the eurozone economy grow.

But also helping corporate Europe is the combination of a weak euro and low oil prices, which Paolini says should have a positive effect on profit margins.

He adds: “Corporate profit margins in Europe are more or less in line with the long-term average which, when seen in the light of a recovering economy, suggests there is plenty of scope for them to expand. This is in contrast with the situation in the US, where margins are at record levels.

“Valuations for European stocks also look reasonable. On measures such as price-earnings and price-to-book ratios, European equities trade at a 10 per cent discount to both their US and global counterparts.”

The strategist highlights too that Japanese companies have benefited from a currency-fuelled improvement in their global competitiveness,  noting that “a weak yen should continue to be a feature of the financial landscape given the Bank of Japan’s ultra-loose monetary policy”.

“At the same time, thanks to improvements in corporate governance, companies are making more efficient use of their balance sheets, which holds out the prospect for a steady increase in the market’s return on equity. Corporate profit margins are also on the rise. None of these developments appear to be reflected in the valuations for Japanese stocks which, on a price-earnings basis, trade at an 8 per cent discount to the MSCI World Index,” he adds.

On the downside emerging market indicators still remain weak, as the severe slowdown in China takes it toll.

While the world’s second largest economy is grappling with a decline in external demand and the need to pare back public investment, industrial production, construction and consumption are heading in the right direction, according to Paolini.

He says: “China’s purchasing manager’s index rose last month – the first time it has registered a monthly increase since March. This modest rebound could gather more momentum if emerging market central banks follow the example set by India and Taiwan, which cut rates to shore up growth.”