The post-election Trump bump has elevated the U.S. market to a lofty PE premium. In the search for value, investors have started to take a hard look at overseas economies. One overlooked market to consider is Europe.  

The Current Situation

European shares continue to lag behind in the global market rally. Investors are still smarting from the European debt crisis that began in 2009 and the surprise Brexit vote of last summer. Further tempering the situation is talk of other countries exiting the European Union, leaving the future of the euro in doubt. Looming elections in Germany and France have muddied the future of the common currency, as populist candidates are holding steady in the polls. Politically, Europe looks like a bit of a shaky bet. European economies have not historically been strong growth candidates, restrained by the aging populations, rigid labor laws and currency constraints.  

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However, buried beneath the negative headlines surrounding Europe are solidly improving growth trends and economic indicators. Eurozone GDP rose an estimated 1.7% in 2016, driven primarily by falling unemployment rates, rising wages, and strong household spending. The Eurozone unemployment rate has hit a seven-year low, manufacturing growth is at its strongest level since April 2011, and business confidence levels remain high. Consensus forecasts are for European corporate earnings to grow at double-digit rates in 2017.

Valuations Look Reasonable  

The valuation perspective is also positive for European stocks, as the indices look relatively cheap when compared to U.S. levels. The likelihood of a continuing strong U.S. dollar vs. the euro, supported by the Fed’s recent rate increase, will preserve the competitive advantage for Eurozone companies.

Investors still appear to be favoring the U.S. markets, suggesting they prefer to stick to the more familiar landscape during political and electoral uncertainty. The pending election uncertainty in Europe is likely a factor for this discrepancy.  

The Election Wildcard

Investors are still smarting from last summer’s surprise Brexit vote, and several upcoming European elections have thrown high levels of uncertainty into the mix. In France, the right-wing candidate is a self-described nationalist who supports a French exit from the Eurozone. Recent polls show her favored by 25% of voters, which has rattled European markets.    In Italy, the anti-Eurozone candidate is also polling strongly. However, in the highly anticipated March vote in the Netherlands, the loss suffered by the populist candidate suggests that pro-populist sentiment may be peaking in Europe. Political populism continues to rise on both sides of the Atlantic. In the U.S., the Presidential election also wrecked havoc on markets, although the positive rally following Trump’s victory left many who bet the wrong way tending to their wounds.  The upshot is elections, and post-election market behavior, are very difficult to predict.  

European “disintegration” is a major destabilizing force for the market right now. Should another country join Britain and drop out of the euro, all bets are off on who will remain committed to the currency and economic structure.  However, it is less clear if there will be long-term effects. The bottom line is while looming elections are injecting some short-term uncertainty into the market, longer term things look positive on a fundamental basis, perhaps making who wins the vote less relevant than investors currently believe. Valuations remain attractive at discounted levels, and many European companies do much of their business outside of the Eurozone, further mitigating risk.

How to Play It    

Although there is no way to completely counter the political risk, investors with a long time horizon can benefit by investing in companies that dominate their market and have a record of profitability and growth.  Stocks with exposure to U.S. domestic markets are especially compelling, as are those defensive plays that can do well in a slower-growth economy.

European equities should be a core holding in a balanced portfolio, with the region offering geographic, political and economic diversification.  Political risk currently remains greater than in the U.S., with several pending national elections injecting some uncertainty into the mix. However, fundamentals remain strong as the global economy rebounds, valuations remain favorable and economic indicators for Europe improve.  

Note: Elaine Phipps, MBA, CFA, is a Portfolio Manager at Point View Wealth Management, Inc., a registered investment advisor at 382 Springfield Ave., Summit.

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