Valuation growth in European equities is being driven by “incorrect” factors, with the Continent being seen as the default option amid ongoing emerging market volatility, Hermes says.

Andrew Parry, chief executive at active equity manager Hermes Sourcecap, said market perceptions, rather than economics, were driving allocations to European equities.

He said this was the case for inflows from the US seen in the latter half of 2013, as well as new interest coming from Asia in 2014, which Parry said was backed by the “perception of value, over the reality”.

According to the asset manager, many areas of the Continent – the euro-zone economies in particular – are still showing GDP levels well below those seen before the global recession and financial crisis.

Hermes chief economist Neil Williams said the mixed competiveness among the euro-zone countries was also hampering its recovery, with the competitiveness of France, one of the larger economies, continuing to slide relative to its peers.

There is also the issue of deflation within the region, with concerns mounting as inflation remains persistently low.

This led to predictions from BNP Paribas that a full-blown round of quantitative easing from the European Central Bank (ECB) would begin by the third quarter of this year.

Laurence Mutkin, global head of G10 rates strategy at BNP, told IPE disinflationary pressure would leave the currency union’s central bank no choice, as other measures had proven ineffective.

Hermes Sourcecap’s Parry said it was nominal GDP that drove overall sales growth in companies and pointed out that this was yet to be seen among the economies.

He said it made him “nervous” that investors were so bullish on Europe, which he argued would lead to mispricing.

Only 44% of listed companies in the European market beat sales expectations last year, with half meeting earnings expectations.

Many stocks and indices have already priced in a full normalisation of GDP and earnings.

“Investors talking about normalisation as though it will be seamless are naïve,” Parry said.

“This is not a tide that will float all boats – some of these boats will have leaks, mainly in their valuations.

“While we’re getting a recovery, it isn’t one that would excite you in real, or nominal, terms.”

However, while Parry said there was still value to be seen in the market, as good companies would grow regardless of ECB decisions.

“You can buy things where there really is value and a growth story,” he said.

“A lot of the time, it is about the company’s ability to deliver, rather than taking the top-down view.”

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