Implications from the reduction in Equity Weights

European Equity returns have also been driven by multiple re-rating rather than earnings growth (Figure 1). Whilst this is normal for the early stage of the cycle, after 3 years in a row of earnings downgrades – investors are (understandably) running out of patience.

UBS sees a recovery in European earnings in 2014 (+10%) and find iteself in the strange position of now actually being above consensus. But there is a near-term risk to equities as we wait for the earnings to materialise (delayed by FX headwinds).

European Equity returns have also been driven by multiple re-rating rather than earnings growth (Figure 1). Whilst this is normal for the early stage of the cycle, after 3 years in a row of earnings downgrades – investors are (understandably) running out of patience.

They see a recovery in European earnings in 2014 (+10%) and find ourselves in the strange position of now actually being above consensus. But there is a near-term risk to equities as we wait for the earnings to materialise (delayed by FX headwinds).

The fall in Sovereign risk (measured by the sovereign CDS) has driven a re-rating of the P/E multiple from c.9x to 13.9x. UBS sees recent concerns over Portuguese banks as a specific issue rather than a wider contagion risk for the periphery. Since 2012 the ECB has put in place the OMT, fundamental macro imbalances (current accounts, deficits) are smaller, and the Global recovery is more mature. Nevertheless, it reminds us just how far periphery Government Bonds have moved.

UBS’ longer term investment case for Europe is based on it being a late cycle play on the global recovery and the depressed level of delivered earnings – still some 25% below their 2007 peak in contrast to the US. There is also significantly higher Operational Leverage and now some tentative signs of profit margins rising in Europe.

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