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Europe: Near term headwinds, long term tailwinds
Anita Patel
December 6, 2023
At the beginning of 2023 there was renewed optimism that this could finally be Europe’s time to shine. After years of lagging the US in terms of economic growth and stock market returns, sentiment for European equities turned positive as they outpaced their US counterparts over the 12 months to the end of June.
However, the second half of the year brought greater pressures. Rising interest rates, slowing economic growth, and central bank rhetoric of a ‘higher-for-longer’ interest rate outlook weighed on both equities and bonds.
While the macro situation is challenging for investors, it is important to separate the external environment from company fundamentals. Looking beyond the macro headlines there are three key tailwinds for European equities.
Attractive valuations and dividends: All-time high discounts for European equities are not simply a function of the high valuations of the US market, driven by the dominance of the tech sector. Across multiple sectors, there are European companies that trade at much lower multiples than their US counterparts.
Europe’s global footprint: Europe is home to some of the world’s most successful multinational companies across diverse sectors and industries. These companies have a global footprint, which can be advantageous as it allows them to benefit from both domestic opportunities and international growth.
Diversified, long-term growth opportunities: US tech giants - the ‘Magnificent Seven’ - have dominated headlines this year and have been the key drivers of US equity market returns over 2023. By contrast, the contribution of Europe’s largest companies has been much more proportionate, even taking into account the strong returns from Novo Nordisk, boosted by sales of its blockbuster diabetes and weight loss drugs Wegovy and Ozempic.
The dominance of a small group of companies – like the US tech behemoths - brings significant challenges for investors. There is evidence that it can increase overall portfolio risk, which is made worse by the business similarities between those companies.
So what’s next for European equities?
There are several exciting investment themes that could be attractive sources of return over the next few years, where European companies hold strong market positions. These include pharmaceuticals, semiconductors, luxury goods, and aerospace and defence.
Taking a bottom-up approach can help identify those companies that have the potential to prosper regardless of the economic backdrop.
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