Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
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A tale of two different European equity markets
Peter Garnry
Chief Investment Strategist
Summary: European equities are down 12% this year whereas US equities are in positive territory and emerging market equities are unchanged. But underneath the bad overall performance a tale of two different European equity markets is hiding showing that a passive approach to European equities that on all measures are extremely cheap is wrong. Investors have to be selective and in our view get exposure to the stable growth companies with high earnings predictability. Those companies will benefit more than others from the low interest rate environment.
In today’s Saxo Market Call podcast, we talked about how emerging market equities had almost fully recovered from the COVID-19 selloff whereas European equities had only recovered half of the drawdown. Asia and especially China is a big component in the emerging market index and the region seems to have managed the COVID-19 outbreak much better with their economic activity also bouncing back faster. As Europe’s rebound was under way a new resurgence in COVID-19 cases seems to be breaking the rebound playbook putting even more pressure on ECB on their Thursday press conference. You can read our ECB preview here.
Stock picking is crucial as there is no one Europe
Back in May we wrote a research note Have US equities finally peaked relative to European equities? Highlighting the grotesque difference in performance between US and European equities since 2007. Most of the outperformance is related to the facts that US companies are dominating the digital economy in the developed world and that European equity markets were still heavily overweight financials which have suffered in the post Great Financial Crisis period.
Whereas emerging market equities are almost unchanged for the year European equities are still down 12%. But Europe’s performance comes in different shades. As the table below indicates there are basically two groups this year in terms of performance. The best performing group consists of the markets: Denmark, Finland, Sweden, Netherlands, Switzerland, Germany, Portugal and Ireland which are up 1% on an equal-weight basis whereas the other group is down 20% with Austria being hit the hardest down 32% year-to-date.
| Market | Largest sector | 12m Fwd P/E | Return YTD (%) | Return 5yr (%) |
| Denmark | Health care | 16.6 | 15.6 | 46.5 |
| Finland | Industrials | 12.7 | 5.6 | 39.3 |
| Sweden | Industrials | 13.1 | 2.0 | 40.9 |
| Netherlands | Information technology | 15.6 | -1.0 | 56.1 |
| Switzerland | Health care | 15.5 | -1.5 | 35.7 |
| Germany | Consumer discretionary | 10.6 | -2.3 | 21.4 |
| Portugal | Utilities | 9.1 | -6.0 | 37.0 |
| Ireland | Materials | 13.8 | -6.0 | 8.3 |
| Norway | Financials | 7.2 | -11.3 | 28.9 |
| France | Industrials | 11.5 | -13.3 | 26.4 |
| Italy | Financials | 8.9 | -16.7 | -4.9 |
| United Kingdom | Consumer staples | 9.3 | -20.5 | 14.7 |
| Belgium | Consumer staples | 13.7 | -23.3 | -17.9 |
| Spain | Utilities | 9.5 | -24.6 | -16.6 |
| Austria | Financials | 6.9 | -31.5 | 2.1 |
Source: Bloomberg and Saxo Group
This divergence in performance is also evident in the 5-year total return numbers so this is long-term trend that has persisted indicating the tale of two European equity markets. In terms of 12-month forward P/ E ratio the best performing group has an average ratio of 13.4x which is still low given the low interest rate environment and given valuation of US equities. The worst performing group has a forward P/E ratio of 9.6 indicating very low sentiment for these markets.
Our view is that valuations are very attractive in Europe relative to many other markets but that investors should be very selective and not buy passively into European equities. As we wrote recently earnings predictability drives valuation premium, so we recommend investors to look for stable growth companies in Europe and avoid the cheap cyclicals and especially financials.
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