Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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The investment case for European equities
Peter Garnry
Chief Investment Strategist
Key points
- Europe's economy: Investor sentiment is improving, real-time GDP indicators suggest the recession is ending, and lower energy prices are easing pressure on businesses and households.
- European equities: Not as attractive as US equities strategically, but offer gems with good value and potential for surprise.
- European defence stocks: Seen as a high growth industry due to the war in Ukraine and Europe's focus on self-reliance.
Green shoots are everywhere
In our recently published Quarterly Outlook we highlighted Europe as the region we like the most tactically in the second quarter. With the momentum in US and Japanese equities many are probably wondering why are bullish on European equities. Let us explain in more details why by going through three macro indicators.
- Sentix sentiment reading on Eurozone economy 6 months ahead just turned positive for the first time since February 2022 and is approaching the average levels seen during expansion periods before the pandemic.
- Bank of Italy’s eurocoin growth indicator, which is a real-time GDP measure, also went positive in March for the first time since August 2022 indicating that Europe’s economy is coming out of its recession.
- Natural gas and electricity prices in Europe are down 34% and 42% from the 2023 average respectively which alleviates pressures for Europe’s industry and households. Lower energy prices will help the going forward.
European equities are not a wonder market, but there are gems hidden in the mud
While we like European equities tactically and one could talk about low P/E ratio and better sector diversification than US equities, European equities are not as attractive as US equities strategically. European companies have struggled for years to grow their revenue faster than inflation offsetting the attractive combination of 3.1% dividend yield and 1.6% buyback yield. Investors betting on European equities are betting that US exceptionalism cannot continue, not even in technology, and that the low equity valuations reflect so low expectations that Europe can only surprise. How to get exposure to European equities?
The two biggest ETFs on European equities are listed below for those that want broad-based exposure:
- iShares Core MSCI Europe UCITS ETF EUR (Dist)
- AUM is €7.6bn
- Total expense ratio: 0.12%
- Amundi Stoxx Europe 600 UCITS ETF Acc
Last year, we wrote a primer on European equities highlighting its different features and where European equities are different from US equities. The five largest industries in the European equity market are health care, industrial goods & services, banks, food beverage & tobacco, and technology. One of the biggest changes from last year is that Nestle is no longer the largest constituent in the Stoxx 600 Index as it has been overtaken by Novo Nordisk as the market pushed the Danish pharmaceutical company higher amid a bonanza for its weight loss drug Wegovy. Another rising star has been SAP that was not part of the top 10 a year ago, but has risen to become the seventh largest stock in the main index.
Underneath the surface of the usual mega caps there is a group of highly profitable and high quality companies that any curious investor should consider. Below we have listed 10 companies with outstanding return on invested capital, the hallmark of operational quality, and outside the mega caps.
- Rightmove
- InterContinental Hotels
- Hermes
- Kone
- Sectra
- Ferrari
- STMicroelectronics
- Geberit
- Inditex
- Tenaris
European defence stocks are key portfolio component in the years ahead
As we also highlight in our Quarterly Outlook, the European defence industry is going to be a high growth industry for years to come as the war in Ukraine has no end in sight, and Europe is determined to rely less on US defence in the future. Military budgets will continue to rise and most likely exceed current expectations. The list below highlights the stocks in our defence basket. Rheinmetall in particular is the most popular European defence stocks among our clients.
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