Hartwig Kos, co-head of multi-asset and vice CIO of SYZ AM, has predicted strong performance for European equities for the first half of 2017, but said a surprise result in Germany's autumn election could unnerve investors later in the year.
He highlighted Europe as one of the most attractive areas in which to invest, as investors have attached a high political risk premium to the region.
This uncertainty led to European equities underperforming developed market peers in 2016, with the Euro Stoxx 50 only increasing 10.4% compared to the FTSE 100 and S&P 500, which rose 21.5% and 19% respectively.
Why markets are too pessimistic on Europe
Kos (pictured) said: "One thing which surprised us in 2016 was the underperformance in European equities. Investors were assigning a high political risk premium to Europe, which was driven by the banking crisis and referendum in Italy and then the different upcoming elections.
"However, we have seen a recovery in European equities since the referendum and I believe this trend will continue in 2017.
"The European equity market has more attractive valuations compared to other markets. When you see the market's behaviour, growth has been slow for a long time, which has been driven by the political risk premium. However, Europe is doing well economically," he said.
Furthermore, Kos predicted investors will be "relieved" by the result of the French election in the spring.
Marine Le Pen, leader of the National Front, received huge support throughout 2016 and is predicted to do well.
However, Kos said this scenario may not play out in the way some investors are anticipating: "Performance will also be driven by investors' relief at the result of the French election as we wouldn't be surprised if the political risk there plays out far better than expected," he said. "This would give a boost to equities for the first half of 2017."
Merkel impact
But the vice CIO said this strong run for equities could come to an end following the result of the German election in September.
Chancellor Angela Merkel is seeking a fourth term in office but her position has come increasingly under pressure from the far right Alternative for Germany party.
Kos said political instability is usually associated with countries such as Spain and Italy, not Germany, which is why he believes the markets could react poorly.
How the rise of political insurgencies and protectionism is threatening investor returns
"The inflection point could be the German election. We have not thought of the notion of political instability in Germany and I think investors will be surprised by the election.
"Although Merkel will be Chancellor, the far right party could excel in the election and have a result that is much better than the market anticipates, weakening Merkel's power internally.
"I would not be surprised if the market takes this badly, as political stability was one of the aspects which was taken for granted in Germany," he said.
