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Quality equities for Europe in 2015, says WisdomTree

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Exchange traded fund provider WisdomTree believes political uncertainty and ‘structural deflation’ will drive the investment outlook for Europe in 2015.

 Both are linked and particularly for the Eurozone’s financial markets, pose major risks. First, no tangible recovery of the jobs market looks realistic in 2015, amidst the relentless fiscal tightening by the state and ongoing deleveraging by the private sector. This is set to help populist fringe parties gain further ground in the polls and fuel the political fracturing of the European Union beyond Greece. Setting the political climate of more independence from Brussels, will be the elections in the UK in May and in Spain towards the end of the year.

The risk to financial markets is the confidence in the European Union and by extension, its fiscal union. 

Second, faced with the fallout in domestic demand and no investment-led growth, the Eurozone’s economy, risks sliding into structural deflation. Against the full scale QE program that exhausts all of the ECB’s stimulus efforts, the markets now depend on Brussels to loosen budget rules and implement scalable investments plans through state funded infra-structure projects to win the fight against deflation. Without fiscal and investment stimulus, the Eurozone is expected to stay in a state of disinflation and at worst, slide deeper into deflation. 

Central to the debate of austerity and fiscal tightening in Europe is Greece, which will seek a renegotiation of the term of its bailout package. The risk of contagion subjects Spain and Italy to potentially more volatility and rising credit spreads, especially if inflation fails to pick up in the periphery and a higher risk of default is being priced in. Such a scenario is likely to further polarize allocations into the safest safe havens and suppress already record low bond yields in Germany and in Europe’s healthier core – deeper into zero, if not negative yields.

Against Europe’s increasingly dislocated bond markets; from the negative yields of core European shorter dated sovereigns, to low yields of long dated Southern peripheral sovereigns and IG corporates; to the high yielding but high risk government bonds of Greece, European equity markets off comparatively better value. 

Cash rich balance sheets and attractive valuations of European stocks mean prospective dividend yields offer investors an historic unprecedented premium to long dated government bond yields. The export bias and global footprint of corporate Europe furthermore mitigate the equity markets exposure to macro-political risks to which the bond markets will overwhelmingly remain subjected.

Defensive positioning in Europe for 2015 may, ironically, require an allocation shift away from bonds and into equities. Within equities a bias towards quality, high-dividend yielding, broad basket of stocks, is made available with dividend index strategies. This is an investment proposition that investors should consider with the view that political uncertainty and deflation would not dissipate.

Longer term, a recovery of Europe may still be in the cards, given the boost QE, coupled with fiscal stimulus would provide to the economy. Small-cap equities most exposed to the region’s revival would stand to benefit more than export driven large-cap equities. An allocation towards a broad basket of small-cap stocks where screening for dividend payers would take a lot out of the speculative element in small-caps, is a strategy European-based investors should consider – if they want to ride out the uncertainty in 2015 and hold on to their investment over this cycle.

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