Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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The stars of Europe's equity market
Peter Garnry
Chief Investment Strategist
Summary: European equities have been the key story in equity markets since early 2022 when the interest rate shock started and inflation turned out to be higher for longer. Not only are European equities outperforming but they are also much more attractive on valuation priced at a P/E ratio of 13.2x compared to 18.5x for US equities. Earnings estimates have also been rising faster this year in Europe compared to the US and this is despite of all the hype about AI. In this equity note we also highlight which 20 European stocks that have contributed most to the outperformance this year.
Key points in this equity note:
- European equities continue to outperform US equities on top of still being much cheaper on P/E and dividend yield.
- 12-month earnings estimates on European equities are outpacing US earnings estimates this year.
- Europe’s stars in the equity market this year have been stocks such as LVMH, Novo Nordisk, and ASML.
European equities continue to shine over US equities
European equities are up 14% this year compared to 8.5% for US equities. If it had not been for the AI hype the numbers would have been even more in favour of European equities. If compare the price change this year to the actual change in underlying earnings and even more importantly the expected earnings then the US equity market has gotten even more expensive relative to European equities. STOXX 600 is currently priced at a forward P/E ratio of 13.2x and dividend yield of 3.5% compared to 18.5x and 1.7% respectively. The risk-reward ratio is clearly in favour of European equities and many US investors are looking to diversify their US exposure with more weight to Europe and Japan. For more perspective on Japanese equities read our recent equity note Will the sun rise over Japanese equities?
It is clear by now that in the age of inflation, European equities have just been better. Since the Covid vaccines were announced unleashing the comeback of the physical world and inflation, European equities have returned 39% compared to 32% for US equities. Since the peak in equities in late 2021, US equities have declined 11% while European equities have only lost 3%. With the US debt ceiling debate continuing and likely leading to a compromise which will include a reducing in the current US deficit then 2023/24 could become a period of lower government growth impulse in the US compared to a bigger impulse in Europe. In other words, European equities offer a better earnings outlook on top of a much lower starting point in terms of valuation. What is not to like?
Earnings estimate upgrades highlight Europe’s momentum
It is not only in terms of performance that Europe is shining these days. When we look at 12-month earnings estimates then analysts have been consistently more optimistic about European earnings. The 12-month earnings estimate on STOXX 600 is up 1.7% this year while the S&P 500 earnings estimate is down 0.1% this year. One of the underlying forces is the demand on the physical world is outstripping demand on the digital world as the fragmentation of global supply chains is driving enormous amount of investments in the US and Europe. But what is more impressive about the performance by European companies is that it is done with a less fiscal impulse compared to the US where the fiscal deficit is around 7% of GDP while Europe is closer to 3.5%. The war in Ukraine has accelerated two powerful forces in Europe, 1) the green transformation which is driving the biggest electrification the world has ever seen, and 2) a doubling of military spending which will cause positive second order effects into Europe’s industry.
The European equity stars in 2023
While the US equity market is driven by the technology and health care sector, the European equity market is more diversified across consumer sectors, health care, financials, and energy. The table below shows the 20 European stocks that have contributed the most to this year’s performance. Out of the 14% total return this year in the STOXX 600 Index, 5.75%-point of that performance have come from 20 stocks which we call the stars of Europe this year.
Three of these companies are within the roaring luxury theme which we have written extensively on during the year and recent as last week in our equity note Luxury stocks do not care about China’s old economy. Luxury stocks led by the French luxury giant LVMH have been the preferred way to express a positive view on the Chinese reopening. Outside luxury stocks, there are three health care stocks (Novo Nordisk, Novartis, and AstraZeneca) that have helped pull the index higher this year. Health care stocks have incredibly high quality and defensive characteristics that are in high demand amid the uncertainty over the economy and inflation. The procyclical boom in infrastructure, green transformation, and the de-risking of supply chains have benefitted industrial and semiconductor companies such as ASML, Siemens, and Schneider Electric; read our equity note from yesterday on the booming demand for electric grid infrastructure in Europe.
On the top 20 list we also find European banks such as HSBC and UniCredit. While there was a brief banking crisis due to the failure of Silicon Valley Bank it has failed to materialise into anything here in Europe except for the merger between UBS and Credit Suisse. European banks have been a positive story this year with expanding net interest income and lower than expected loan loss provisions. US banks have underperformed European banks by a wide margin the past year as explained in our recent equity note Equity update: US banks, European earnings, and Apple earnings.
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