European Equity Outlook for 2024
In our September 2022 commentary titled “European Equities – Winter is Coming?”, we highlighted the opportunity presented by European equities due to ultra-bearish sentiment exhibited by investors at the time. Investors expected multiple factors would cripple the continent’s economy, most notably, the Ukrainian War and its concomitant energy supply disruption. Additional hurdles included US-like, stubborn inflation pervading the continent, potentially crimping consumer spending; the worst drought in centuries handicapping critical river transport, crippling commodity shipping; and the always-present political intrigue, legislating business-unfriendly policies. Understandably, many investors sold anything European, initially pulling stock prices lower as well as the euro. Surprising to many, European equities excelled vis-à-vis other major regions since early September 2022. While the market rallied to somewhat pricier levels, and economic challenges remain, we believe the region offers many attractive investment opportunities and should continue to rank high in relative equity returns going forward.
Measured from September 6, 2022, the day of the earlier published piece, through year-end 2023, European equities outgained all other regions in the MSCI All-Country World Index IMI, returning +35.82%, handsomely exceeding the Asia Pacific region (+14.51%) as well as the US (+22.37%). (Note, no exclusion for the magnificent seven necessary in these comparisons.) While a limited number of technology leaders boosted the US return, the European gain showed much greater breadth with all sectors posting double-digit returns, led by Financials (+54.61%). We highlighted the compelling European equity valuation in the earlier commentary, and that ultra-attractive valuation does not typically require a catalyst to work in investors’ favor. Despite the better recent performance, relative valuation still favors Europe. The banking industry illustrates the skew. On average 40% better capitalized, and posting better profitability compared to US banks, European banks still trade 20% to 40% cheaper depending on the valuation metric used. Other industries generally reflect a similar valuation advantage.
In spite of the equity momentum, gloomy sentiment persists. Granted, much of the continent suffers from sluggish growth at the moment, including the continent’s most important economy, Germany. Some indicators, such as the PMI Surveys, suggest an imminent recession for the continent, showing economic output recently declining at the fastest rate in 11 years, and new orders, a key metric for future demand, distressingly falling for 20 straight months through November. The downturn appears to be hitting both manufacturing and services with employment growth stalling. Some contend that without Russia’s cheap energy, and with a downshifting Chinese economic engine hurting exports, Europe’s economy will continue to struggle. Many paint a dreadful picture by pointing out deteriorating demographics and potential for immigration flareups between countries. As indicated above, however, Europe has traversed this road before.
True, as chief trade partner for Europe, China’s slowing demand for machinery, electronics, and luxury goods blew a stiff headwind against the European economy in 2023. China’s recovery disappointed after reopening, but investors failed to appreciate the psychological scars left from the extended, devastating Covid lockdowns. Hardships from forced closures of businesses, shops, as well as job losses, and reduced mobility were not easily forgotten. Fear of renewed infection and punishing government policy gripped Chinese businesses and consumers alike throughout the year. Understandably, anxiety lingered, consumers sought to rebuild savings, not spend, and cautious businesses postponed hiring and investment. Recent data, however, shows this crisis of confidence fading. Retail sales growth, almost flat lining in July, rebounded at year-end to double-digits. Industrial production, accelerating since May, now registers a respectable 6.6% year-over-year growth rate at its latest reading. Even the plagued real estate industry shows signs of stabilization. Moreover, vibrancy returning to China should reverse the drag and be a positive European growth driver in 2024.
Focusing exclusively on China, however, misses the bigger, crucial development in the European trade story. An economic powerhouse in its own right, Asia Pacific excluding China continues to experience robust growth, and the increasing interconnectedness boosts Europe’s economy. European Union trade with other Asia Pacific countries totals more than four times its trade with China. With Europe’s exports to this region now over $1.1 trillion, and growing over 30% per year, this is a needle mover for Europe’s $21 trillion economy. Markets such as Indonesia, India, and Thailand seek greater integration into global value chains, and depend mainly on Europe to develop each of their areas of production specialization.
While the domestic economy still faces challenges, we believe the recent improving economic sentiment not only reflects the tourism rebound, but speaks generally to Europe’s increasing resiliency. New EU legislation and tools, such as the European Stability Mechanism, provide greater fiscal and monetary coordination, enabling the bloc to better navigate economic turbulence. Germany, of course, remains the cornerstone. Sound finances, a low unemployment rate, a world-class skilled workforce, and robust manufacturing will continue to provide a sound foundation for Germany’s export dependent economy as well as to Europe, overall.
Finally, we point out Europe’s domestic economy showcases many profitable innovations, and our investments target many of these areas of leadership. For example, Schneider Electric exemplifies the continent’s lead in energy efficiency and automated manufacturing; Dassault Systemes’ high-end 3D software excels in AI-aided design for products ranging from airplanes to autos to drugs; MTU Aero Engines supplies critical, specialized components to all of the world’s major aircraft engine producers; and finally, luxury behemoth LVMH remains in a class of its own for product craftmanship, defining luxury, and creating new customer experiences. These are just a few examples of high-quality, Europe-based companies with great products and the ability to sustainably grow over time.
In conclusion, investors should maintain a balanced perspective to cover the global economic landscape. Acknowledging all regions have challenges, but also potential, we believe European equities, operating in a region with a bright future, belong in most investor investment portfolios.
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