Although it is encouraging that global equities recovered forcefully following the surprise vote for U.K. to exit the E.U., Brexit risks aren’t over for European markets, said Zack Apoian, senior asset allocation strategist at Morgan Stanley Wealth Management. ‘Despite the pause in news flow, volatility is likely to result from uncertainty surrounding the timing of invoking Article 50, posturing during the negotiation process, and the potential for other countries to move toward exit,’ said Apoian. Constrained profitability also poses a concern in his view. Even though Europe has grown, companies have had difficulty executing and allowing this to translate to profit. Return on equity (ROE) is roughly 7% across Europe and the U.K. versus 11% in the U.S. Apoian said the tenuous state of Europe’s banks also poses a risk to returns. ‘Banks across continental Europe have struggled, and questions remain about their ultimate success in the face of negative interest rate policy,’ said Apoian. ‘In particular, Italian banks may need to be bailed out. The ECB has delivered forceful policy response in the recent past, but this does create uncertainty.’ Despite these risks to Europe, Apoian maintains there is relative value to be found. The European market sells for around 14 times forward earnings versus 18 times for the U.S. and yields over 3% compared with 2% for the U.S. ‘We would recommend some allocation, but would not overweight it,’ said Apoian. At the same time, Apoian is warming to emerging market (EM) equities, which have led global markets in 2016 after underperforming in the first half of the decade. He said the slower pace of Fed rate hikes helps these nations, which are very sensitive to global liquidity. And stabilized oil prices benefits many EM nations, particularly those in Latin America and Emerging Europe that derive much of their revenue based on oil sales. ‘EM should benefit from an improving macro picture,’ said Apoian. ‘The stabilization of the U.S. dollar following its tremendous run in 2014 and 15 helps to ease the debt load of many EM nations as they borrow in dollars but generate revenue in their local currency.’
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