LONDON (Reuters) - This was to be the year when Europe, stumbling from crisis to crisis over the past decade, was finally sunk by a wave of populism sweeping across the world.
Worried about a politically fragile, increasingly divided and risky region investors turned their backs on European stocks, pulling out more than $100 billion over the course of last year.
But dissipating political risks, particularly those that threatened the very existence of the euro and the financial system on which it is based, and a spring in the step of Europe Inc after six years of disappointments, are spurring a scramble to get back.
A vote against Italian constitutional reforms in December failed to produce a market crash, the Austrian and the Dutch elections went against the populist tide, and even Greece has now agreed on reforms that pave way for debt talks.
In France, the odds of a far-right euroskeptic who wants out of the single currency winning Sunday’s presidential run-off vote remain low. And in Germany, should Angela Merkel unexpectedly lose her seat in the September elections, she is likely to be replaced as chancellor by an arguably even more pro-European candidate in Martin Schulz.
These fading political risks have quickly made way for stronger fundamentals to return to the fore.
Even so, less than 10 percent of the money that left European equity funds last year had returned as of last week, according to Bank of America Merrill Lynch, leaving the tantalizing prospect of a rush back into stocks as more investors get drawn back in.
The euro zone economy started the year with robust growth that far outstripped that of the United States, preliminary estimates from the European statistics agency showed on Wednesday.
Depressed economic activity, stubbornly sluggish corporate profits and negative interest rates have given way to a sharp uptick in consumer and business confidence, double-digit earnings growth and near-record corporate deal-making.
Add to this the creeping realization that investors are not positioned to capture a big upswing in Europe and that stocks are still available at more attractive valuations than in other developed markets, and the much-talked about risks associated with politics seem to pale.
“We believe there are times you get paid to take risk and as a result, we feel investors should add to Europe now,” said Vadim Zlotnikov, Chief Market Strategist at AllianceBernstein.
“...and then add more following the election,” Zlotnikov said, referring to Sunday’s French vote.
Favorite to enter the Elysee palace is centrist Emmanuel Macron, a former investment banker who promises to ease state regulations while protecting workers, but who will need to win big in June parliamentary elections to push through his reform program.
One of the clearest signals bolstering the case for the region, and one that investors were eagerly awaiting, is the revival in Europe Inc’s fortunes.
European profits are enjoying their best run in seven years with first-quarter earnings growth tipped at 13.9 percent, according to Thomson Reuters I/B/E/S.
For the first time since 2010, analysts are upgrading forecasts at this time of year rather than succumbing to disappointments and rolling back overly optimistic projections.
Morgan Stanley says the breadth of Europe’s earnings upgrades is at the strongest level since 2010, with cyclicals and defensives and financials and commodity-related companies all looking healthier, suggesting a recovery is broad-based.
UBS’ Nick Nelson notes that factories in the eurozone are increasingly running with less spare capacity amid a recovery in demand, with Germany leading way but France, Spain and Italy catching up.
Meanwhile, company results show that sales are picking up sharply, suggesting better demand is driving profit growth rather than cost-cutting.
These factors are part of the reason Blackrock, the world’s largest asset manager, turned bullish from bearish on European stocks earlier this year via two swift upgrades since December, saying political anxieties were over done.
Waiting in the wings, however, is a European Central Bank cautiously eyeing signals to roll back from its ultra-loose and unconventional monetary policies, especially as inflation rebounds.
“A Macron victory may be the last piece of the puzzle for Draghi to begin tapering Quantitative Easing at the June European Central Bank (‘ECB’) meeting,” wrote fund managers from Man Group.
That, though, is not the market’s consensus view, which expects the ECB to start winding down its program to buy government bonds only next year.
This would leave Europe in a sweet spot where growth and corporate profits are rebounding, political risks are melting away and a relatively accommodative central bank in no rush to slam on the brakes.
Additional reporting by Dhara Ranasinghe and Kit Rees; Editing by Mike Dolan and Richard Lough