Many investors gave up on continental Europe in 2016, resulting in a net outflow from European equity markets for the first time in five years. Such a stance continued to make sense at the turn of this year, when optimism was riding high in the US and the risk of further populist upsets in Europe was all anybody could talk about.
But now spring has arrived, the world looks a bit different. The global economic environment has improved markedly in ways that would usually benefit European companies more than most. Arguably, the balance of political risks has also shifted in a positive direction.
With the French and German elections getting closer and continued uncertainty in Italy, there is still scope for voters to cause investors trouble.
But for the first time in a long time, there is also a chance that politics in the eurozone will not just muddle along and in fact end the year in a stronger position to support growth and reform. At the very least, investors should stop assuming political change can only make things worse.
The most important economic change is the prospect of reflation, not just in the US but globally.
Global manufacturing PMIs hit a multi-year high in January and eurozone PMIs are also at their highest levels since 2011.
Just as vital to global inflation prospects is the easing of deflation in China. Chinese producer price inflation has been running at an annual rate of 6.7 per cent since December, which is the fastest quarterly pace in more than five years.
That lack of deflationary pressure from China by itself will not push the eurozone’s inflation rate back to the 2 per cent target, but it should make a meaningful difference to nominal growth in the region, which should feed through into higher corporate earnings.
With inflation still low, investors know monetary policy will remain extremely loose in the eurozone for some time to come, despite rising rates in the US. But they have also grasped that the European Central Bank does not see any further benefit in flattening the yield curve, or pushing 10-year bund yields lower and lower.
The resulting rise in long-term lending rates means the performance of European financials should improve and another major drag on the European stockmarket will lift.
Another positive for Europe is that the profits of companies there have traditionally been more sensitive to changes in global growth than other markets.
But despite these improving fundamentals, there remain two big reasons why investors continue to give the eurozone a wide berth: history and politics.
The history is that European equities have been underperforming the S&P 500, with few interruptions since 1987.
In dollar terms, the return on the US market has been 2.5 per cent a year higher, on average, since the start of the century.
There are many reasons for this shortfall, particularly low nominal growth relative to GDP in the eurozone and an over-reliance on under-performing sectors such as financials and commodities rather than stronger performers such as technology.
Political risk has also been a constant problem and we face plenty more of it in 2017. For example, we cannot be sure Emmanuel Macron will be elected President of France. There are also important question marks about his capacity to command a workable majority in the French parliament.
Similarly, in Germany, it would be a brave investor who assumed Martin Schultz would prevail over Angela Merkel.
That said, the probability that Macron and Schultz will come out on top is a lot higher than it was at the start of the year, and surely higher than that of Marine Le Pen upturning the status quo in France.
If we did see victories for Macron and Schultz, we might – just might – be looking at not only a revived centre-left, pro-European majority in the heart of Europe but also, crucially, a more constructive relationship between France and Germany. That kind of positive realignment in Europe is probably not the most likely outcome from here, but it is at least as likely as the populist path to hell.
This is not an argument for blind optimism. It is an argument for including downside and upside political risk in the equation for European markets this year, at a time when the economic fundamentals are strengthening. The long-term challenges for Europe are still immense but investors with a 12-month time horizon who gave up European equities in 2016 may end up wishing they had given it one last shot.
Stephanie Flanders is chief market strategist for Europe at J.P. Morgan Asset Management