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With the continued focus on the “Magnificent Seven” and the technology sector more broadly, I think it is easy to overlook the potential of European equities beyond the so-called “GRANOLAS”, 11 leading companies that have accounted for most of the recent European equity market gains. While European benchmark indices lagged their US counterparts in 2023, European equities outperformed all major markets on an equally weighted basis. Despite remaining under pressure, in my view, the backdrop for European equities is increasingly attractive for active investors on both a short- and long-term basis.
European economic momentum is in the process of inflecting higher. This may seem counterintuitive as the region’s economic performance remains underwhelming. Notably, Germany — Europe’s powerhouse — is still struggling to adapt to a new structural environment. At the same time, European earnings are coming under pressure as inflation normalises. However, leading economic indicators across much of Europe are clearly rebounding and valuations are reflecting the risk to earnings. I would be cautious of areas where margins might have been artificially expanded on the back of strong nominal growth (the main driver of earnings) but I like European companies and sectors with resilient earnings and positive earnings revisions (e.g., health care).
Over the short and medium term, I think that the performance of European equities will, to a large degree, depend on five factors that I am monitoring closely:
While it is my conviction that opportunities will be mainly found at a company level, the following perspectives can help with portfolio positioning:
The two key risks I’m focusing on are a slowdown in the global cycle and a surge in geopolitical tensions. If markets started to worry again about the potential of a US recession, European equities would struggle to do well in light of their cyclicality. Increased geopolitical tensions would also be detrimental given Europe’s open economy, dependence on energy imports and large export exposure to China.
I see potential to mitigate some of these near-term risks through allocations to European defensives, including utilities, telecoms and health care. By contrast, I would largely avoid consumer and industrial cyclicals, which are already pricing in a sharp recovery given their rally at the end of 2023.
I believe European and global markets are currently going through a paradigm shift as we enter a world of structurally higher inflation and higher rates amid deglobalisation, growing geopolitical rivalry, changing demographics and climate change. In turn, these developments are leading to increased political intervention and an emphasis on national security and resilience, onshoring and greater fiscal spending. For investors, this may mean that:
I believe that each of these developments is likely to create more divergence and volatility. I think active investors will be well placed to exploit the associated investment opportunities, provided they are able to combine fundamental company research insights with an accurate understanding of the relevant sector, country and macro dynamics.
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