BNP PARIBAS ASSET MANAGEMENT

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1 BNP PARIBAS ASSET MANAGEMENT Snakes and Ladders After playing snakes and ladders for the whole of 2017, the Euro Stoxx index (SX5E) made a new two-year high this week. The recent rally in the eurozone equity market has largely been driven by the ECB s 26 October announcement that it would extend its quantitative easing programme (QE) by another nine months starting in While this announcement was in line with market expectations, the market interpreted it as dovish; the EUR sold off and bonds rallied during the day. This latest dovish delivery of the QE extension has made us rethink our own expectations (ECB: Loose cannons 1 November). Despite continued solid growth, we expect policy to remain accommodative for a long time to come. We now think the ECB will extend QE by another three months in June 2018, and only expect the first rate hike in June Growth remains supportive of eurozone equities Eurozone growth has remained solid this year and inflation is only gradually picking up. The recent continuation of QE is likely to support this growth trend. The eurozone recovery has been widespread across countries and sectors. It has also been very much led by domestic demand, reflecting a virtuous circle of growth, confidence and employment creation. As such, we believe the recovery will be self-sustaining and less vulnerable to potential adverse shocks than it has been in the past. In addition to the strong growth momentum throughout the year, the Bloomberg economic surprise index has remained positive, despite economists revising up their expectations (Chart 1). We therefore think growth will remain robust (Chart 2) and well above its trend, implying that slack will continue to be absorbed at a relatively fast pace. At the current growth pace, the output gap could close by around the end of This strong growth momentum and continued positive economic surprises could continue to support eurozone equities, in our view. The current leg of the Euro Stoxx 50 rally could drive it to new post-crisis highs, especially considering the undercrowded positioning of eurozone equities.

2 Earnings growth likely to remain robust Strong economic momentum in eurozone and globally is translating into a strong earnings momentum for eurozone equities (Chart 3). So far, concerns of a stronger euro have not been a headwind for eurozone earnings momentum. Through the course of 2017, Euro Stoxx 50 earnings have been revised up by 1-2% for 2017 and Since 2009, earnings have been revised down by an average 5% from January to October. This year, Eurostoxx earnings momentum has been 7% better than an average year since 2009, despite a stronger euro. We believe the gradual strength of the euro could be weathered by eurozone large cap equities, as there could be an offsetting effect from FX hedges by large eurozone exporters and a stronger global growth environment. That said domesticallyexposed eurozone stocks may still see the strongest earnings momentum.

3 Financial conditions have stayed loose in Europe Financial conditions remain loose by historical standards, even in the eurozone (Chart 4), where the currency index has strengthened by 5% year-on-year. This has been offset by other factors such as low interest-rate spreads and historically low high-yield credit spreads. No sign of euphoria from European investors According to the European Fund and Asset Management Association, European-based equity funds have enjoyed steady inflows in 2017, above those seen in 2015 and However, when equity fund flows are compared to bond and multi-asset funds, this equity trend looks far less impressive. In fact, the equity UCITS fund inflows of EUR 64bn over H are only a quarter of the combined flows into bond and multi-asset funds(chart 5). Investors seem to have been scarred by the huge drawdowns of the last two bear markets. Risk-averse European households are keeping their long-held investing bias towards real estate, life insurance policies and cash deposits. We see further potential for flow into equities and equity funds such as ETFs in Europe, as asset allocation slowly shifts away from cash deposits and guaranteed-yield life insurance funds. The investments in the funds are subject to market fluctuations and the risks inherent in investments in securities. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay, the funds described being at risk of capital loss. For a Complete description and definition of risks, please consult the last available prospectus and KIID of the funds. Investors considering subscribing to a fund should read carefully its most recent prospectus and KIID that can be downloaded free of charge from our site Please note that this document may contain technical language. For this reason, it is not recommended for readers without professional investment experience.

4 Looking further into ETF flows, European ETFs have failed to see inflows since the summer months (Chart 6). We think the latest ECB announcement could trigger another round of inflows into eurozone equities. Valuations remain attractive Eurozone equity valuation still looks attractive compared with other asset classes in the eurozone (Chart 7). The earnings yield of c. 6% looks very attractive compared with an investment grade bond yield of less than 1 percent. Favoured European equity ETFs Our favoured ETF strategies for taking exposure to European equities include: Small-caps: the domestic bias of European small-caps is an excellent way to benefit from strong Eurozone macro momentum, pointing to the BNP Paribas Easy MSCI Europe Small-Caps ex CW (EESM FP) 1 ; 1 is a Sub-fund of the SICAV BNP PARIBAS EASY UCITS V Compliant SICAV registered under Luxembourg law.

5 Momentum: the Momentum smart beta factor is another way to gain exposure to the current macro growth trends in Europe, via the BNP Paribas Easy Equity Momentum Europe (EMOM FP) 2 ; Dividend income: Quality dividend income is a popular strategy for income-oriented investors at a time when cash, bond and credit asset classes all sit at close to historic yield lows; we would look to the BNP Paribas Easy Equity Dividend Europe (EDEU FP) 3 in this regard. 2 is a Sub-fund of the SICAV BNP PARIBAS EASY UCITS V Compliant SICAV registered under Luxembourg law. 3 is a Sub-fund of the SICAV BNP PARIBAS EASY UCITS V Compliant SICAV registered under Luxembourg law.