Home Stock & Shares Are European Stocks Due A Surge?

Are European Stocks Due A Surge?

by Jonathan Adams
European stocks

It’s not been a great few years for European stock markets in the context of their performance relative to global rivals. That was the case pre-coronavirus crisis and Europe-centric investors have now also watched Wall Street’s major indices largely recover from the March sell-off. Europe’s stock markets have recovered ground but are still some way off their highs set in January and February.

stoxx

Prior to a dip this week, the tech-focused Nasdaq had even set a new record high earlier in June. In Europe, the broad-based STOXX Europe 600 is still over 17% off its February high. Which was already lagging behind the gains achieved elsewhere in the world over the last few years of the long bull run equities had enjoyed since the last global economic crisis over a decade earlier.

Which begs the question, have Europe’s companies and stock markets been fundamentally weaker than global rivals? Or are they now due a belated catch-up rally? Alternatively, have valuations elsewhere been over-inflated and Europe has simply remained sensibly priced? That would mean investors in European equities are out of luck and those with exposure to other global markets should consider banking profits now while the going is still good.

European Equity Returns Have Lagged Behind The Rest Of The World And Investors Are Not Impressed

Over the past 5 years, the MSCI Europe ex-UK Index has returned just shy of 40% (39.3%). At an average annual return of just under 8%, that doesn’t sound bad at all. But everything is relative. Over the same period, the S&P 500 returned 93.3% and the MSCI World index 67.9%.

Brexit concerns and economic challenges for Europe have both contributed to putting a damper on equity markets in the region. But relatively poor returns have been exacerbated by investors pulling their funds out of European equities in favour of better performing international competitors.

Investment Association data shows private UK investors pulled £3.8 billion from European funds last year – a record. And over January of this year, European funds were the only regional sector to have net retail outflows, down £86 million.

europe lags behind

Source: The Times

What’s Gone Wrong For European Stocks?

The coronavirus crisis hit western Europe hard but the impact has been intensified by the fact the region was struggling economically heading into the pandemic. Brexit uncertainty has been a dampener for a few years now, as have been other political and debt issues in the eurozone.

That’s culminated in a weaker bounce back from the global equities sell-off in March compared to on Wall Street and across other developed markets. Emma Wall, head of analysis at online investment platform Hargreaves Lansdown explains:

“Europe became the unexpected epicentre of the Covid-19 crisis, with certain countries suffering devastating effects. Their governments in turn imposed the most strict lockdown measures to control the spread of the coronavirus. This, unsurprisingly, affected stock markets as whole sectors of the economy were shut down.”

Summer tourism is very economically important to southern European economies such as Spain, Portugal, Italy and Greece. Even if some level of tourism returns over July and August, it will be far from the usual levels. The same economies have also been most affected by debt and slow economic growth over recent years, compounding the coronavirus effect.

The 2019 slowdown in global growth also hit export-orientated Europe especially hard. Germany, with the automobile industry the country’s largest industrial sector, dropped into a manufacturing recession in 2019. Investors are also concerned by the opposing forces of European nations who would like greater economic and political integration across the EU, such as France and Germany, and others who would prefer a loosening of common rules and regulations.

It’s not difficult to argue that rival markets, especially the U.S., are overvalued but in the shorter-term sentiment is a powerful mover of markets. And a 3.6% drop in Eurozone GDP over the first quarter of the year, and better jobs figures than expected out of the U.S., has seen investors pull funds from Europe and invest in the USA.

Wall continues:

“It underlines how much animal spirits are driving markets at the moment. Fundamentals remain largely unchanged, restrictions still apply across the world and are stifling revenues, but economic and health news can spook or enliven markets.”

Will Europe’s Economy Bounce Back?

The medium to longer term economic growth outlook for Europe has also acted as a cloud over the Old Continent’s financial markets. Credit ratings agency Scope Analytics thinks it will be at least 2022 before GDP recovers back to 2019 levels. Dierk Brandenburg, commenting on behalf of Scope forecasts “even when they do, it will be mainly due to huge fiscal stimulus that will eventually have to be withdrawn.”

What is the economic recovery plan? The EU plans to borrow around €750 billion against government guarantees to fund a pandemic recovery fund that is planned to help support the worst hit countries and sectors.

But there is already dissent around the plan. The notoriously frugal four of the Netherlands, Austria, Denmark and Sweden think the fund is too large and aggressive and will lead to waste. Because the cost of repaying the loans that will fund recovery plan grants will be met by all EU taxpayers, the plan needs unanimous approval from all 27 EU member countries. Getting it over the line could reawaken political tensions simmering across the EU.

Will European Stock Markets Rally To Close The Gap That Has Opened With International Peers?

But, as perfectly demonstrated by Wall Street, the European economy will not necessarily be reflected in its stock markets. There are many highly successful European companies earning revenues globally. And while Europe has its troubles, it’s certainly not the case that everything is economically rosy in the USA and elsewhere.

European companies don’t have obviously weaker fundamentals than international peers. That means there are 3 obvious scenarios. The first is that other stock markets drop back to valuations more in line with those in Europe. The second is that European valuations catch up with other markets. And the third is a meeting somewhere in the middle.

Pre-coronavirus it was the second scenario that looked to be unfolding. The margin between European and American and other developed market stocks was narrowing. The MSCI Europe ex-UK index has returned 7.27% between February 20 and mid-June, compared to minus 4.61% for the S&P 500 and minus 5.37% for the MSCI World.

Pro-European markets analysts argue that many of Europe’s strongest looking stocks currently trade at ‘undemanding’ valuations that look significantly lower risk at the price than alternatives elsewhere.

Just a handful of suggestions worth a close look by investors include German sportswear giant Adidas and the Swiss food conglomerate Nestlé. The former has roughly trebled in value over the past 5-6 years and the latter doubled.

The Times columnist Ian Cowie is a fan of Swiss flavours and fragrances company Givaudan. It’s not a well-known brand itself but its products are used in the food and drinks of many that are. It’s almost doubled in value in the past 3 years. He’s also a fan of Dutch brewer Heineken, owner of a huge stable of international beer brands.

As always, there are no guarantees, but investors would be wise to cast an eye over strong looking European stocks whose valuations look attractive for no obvious reason other than the fact international investors have temporarily fallen out of love with the region.

Important
This article is for information purposes only.
Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.
There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.

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