European stocks are the most promising as far as international stocks are concerned, according to new research from CitiGroup, displacing the "old leadership" from the US.
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European equities in general should provide 40 per cent returns to the end of 2016, said the paper, while financial stocks could be expected to provide even better returns than that.
In a paper titled All Roads Lead to European Financials, Citi argued that "a new leadership group and a new investment regime is upon us".
Whereas quality/low risk and US stocks were once the best stocks to own, over the past six to nine months there had been a change in the investment landscape, Citi said.
"On a regional basis it is Japan and Europe, which are showing the strongest dividend per share momentum currently," Citi said. "Within Europe it is financials and consumer discretionary, which have enjoyed the sharpest rise in dividend per share since 2012."
Bloomberg data shows that the German DAX is a leading performer, up 20 per cent year to date, and the Euro Stoxx is up 16.18 per cent.
This momentum is set to continue, said the paper, with European and Japanese stocks remaining overweight in the Citi portfolio.
Citi have defined Europe as excluding Britain for the purposes of the paper.
"We have argued that investors should back markets offering a combination of attractive fundamentals – for example, earnings per share growth – supported by liquidity, for example quantitative easing," Citi said.
Both Europe and Japan "have fitted these criteria for us … the earnings per share delivery story in Europe is only just starting, in our view."
Game changer
The appeal of European financial stocks has been fuelled by European Central Bank quantitative easing, which Citi labelled a "game-changer". Whereas de-leveraging supported low-risk/quality stocks, leveraging supported financial/cyclical stocks.
Using the three criteria of dividend yield, dividend momentum, and dividend yield plus growth, "all roads lead to European financials," said the paper.
By these criteria, five sectors recorded above-market scores – financial services, insurance, banks, basic resources and telecoms.
All three of the financial sectors were rated "overweight" by Citi while the other two were rated "neutral".
Financial stocks included banks such as UBS, Danske Bank and Nordea, insurance companies including Aviva, AXA and Zurich, and financial services companies Aberdeen and Provident.
European banks shares have jumped 28 per cent since a January low, but they're still trading at a discount to their two-year average, making the industry among the cheapest in the region. The cost of options protecting against bank stock swings this month reached the lowest level in more than five years versus those on the Euro Stoxx 50 Index.
"Our base case remains that European equity markets can continue to make strong gains in the coming 12 to 18 months even against a backdrop of rising rates/yields, provided the rise is not too sharp or sudden – that is, no inflation break out."
Financial stocks, including those in Europe, were also backed by Morgan Stanley.
"Financials have been a clear underperformer during the global financial crisis and the eurozone sovereign crisis, and have hardly recovered any ground versus the index," Andrew Sheets, chief cross-asset strategist at Morgan Stanley in London, wrote in a note last week. "The sector is one of our most preferred globally."