* European clouds lifting ... except in politics
* GRAPHIC: U.S., euro zone P/E ratios: bit.ly/2kZcuY3
* Euro zone economy humming along nicely
By Jamie McGeever
LONDON, Feb 21 Politics have rarely been more
fraught on either side of the Atlantic in the post-war era, and
yet European stocks are marching steadily higher - casting doubt
on the old adage that markets don't like uncertainty.
Voters go to the polls this year in France, The Netherlands
and Germany on a rising tide of populism that is out to
challenge the established order built since World War Two.
None of the far-right parties seems to have a strong chance
of securing power. Nevertheless, since the surprise outcome of
last year's U.S. presidential election, financial markets remain
particularly apprehensive about the possibility - however slim -
of the anti-euro Marine Le Pen winning the French presidency.
But the improving European economy and a recovery in
corporate profits, at a time when debt yields are still
historically low, gives investors little choice but to remain
heavily invested in riskier, higher-yielding assets such as
equities. That leaves bond markets to reflect the anxiety.
Figures on Tuesday showed that despite the political
uncertainty, euro zone private sector and manufacturing growth
accelerated to near a six-year high in February and job creation
reached its fastest since August 2007.
"We just don't know how these political risks will play out.
It's incredibly difficult to take actionable, informed
investment decisions in this environment, so some portfolio
managers aren't making any changes," said Neil Dwane, global
strategist at Allianz Global Investors.
"In the meantime, investors have to hunt for a return," said
Dwane, who was previously the group's Europe Equities chief
That's a widely held view in an investment community still
struggling to explain 2016. Even those who sailed against the
tide to predict Britons would vote to leave the EU and Donald
Trump would make it to the White House would probably have been
wrong-footed by the subsequent moves across stock markets.
Apart from initial short-lived volatility, they have climbed
steadily. Investor bets on Trump's fiscal largesse and tax cuts
reflating the U.S. economy have put a rocket under Wall Street,
especially bank stocks, and Europe has benefited too.
Euro zone stocks have lagged Wall Street this year. The
Eurostoxx 50 is up 2 percent year to date, less than
half the 5 percent increase that has lifted all three major U.S.
indices - the S&P 500, the Dow Jones Industrial Average
and the Nasdaq Composite - to record highs.
But over a slightly longer period, the Eurostoxx 50 has
outperformed the S&P 500 since Trump's victory on Nov. 8, rising
11 percent compared with 10 percent. That has been achieved
without the huge inflows from retail investment funds which have
propelled U.S. stocks.
According to fund flows tracker EPFR, U.S. equity funds have
drawn a net inflow of $84 billion since the election, of which
$10.9 billion has come this year. European funds have posted a
$511 million net outflow since election day, but a $606 million
inflow this year.
"People are still under-allocated to Europe. Retail money
has gone into U.S. markets, but not Europe. Not yet," said
Stephen Macklow-Smith, head of European equity strategy at JP
Morgan Asset Management.
In The Netherlands the anti-Muslim, anti-EU party of Geert
Wilders holds a narrow lead in opinion polls but even if he wins
parliamentary elections he will struggle to form a coalition
government with mainstream parties.
In Germany, the far-right Alternative for Germany is polling
just in double figures but conservative Chancellor Angela
Merkel's chief threat is from the mainstream, pro-Europe Social
That leaves investors to worry particularly about Le Pen's
anti-euro stance in France. Polls this week showed the National
Front candidate is narrowing the gap on her more centrist
opponents if, as expected, she makes it through to a
second-round run off scheduled for May.
The bond market reacted quickly and decisively to the polls.
The premium investors demand for holding 10-year French debt
over ultra-safe German bonds shot up this week to the widest
since 2012, at around 85 basis points
Still, at just over 1 percent, France's nominal 10-year
borrowing costs are less than a third of what they were at the
height of the euro zone debt crisis in late 2011.
Stocks are taking a much more sanguine view. At 14.9
currently, the Eurostoxx 50 measure of implied volatility
is near its lowest ever levels. It has posted a monthly
close below 15 only once in over 10 years.
On valuation terms, there's also a case to be made for the
euro zone relative to Wall Street. The price-to-earnings (P/E)
ratio for the S&P 500 index is now at 17.8, well above the euro
STOXX 50 index's 13.85 times its 12-month forward
earnings, according to Thomson Reuters Datastream. That gap has
rarely been greater. bit.ly/2kUiEYv
Macklow-Smith at JP Morgan Asset Management notes that
European banks' return on equity (RoE) last year was about 4.3
percent, compared with a 10-year average of 7.4 percent. Before
the crisis, it was between 10-15 percent.
Because the average RoE over the last decade has been so
skewed by the global financial crisis and then the euro zone
debt crisis, there is reason to believe it will be higher over
the next decade.
Stephane Monier, Head of Investments at Lombard Odier
Private Bank, said he started to reduce his underweight position
in European equities last month, even as the political outlook
"Given a constructive macroeconomic environment and positive
earnings dynamics, we are keeping the overall level of equity
risk in portfolios unchanged at slightly overweight," Monier
(Reporting by Jamie McGeever; Graphic and additional reporting
by Atul Prakash; editing by David Stamp)