Europe – a continent left behind or investment opportunity?
Editorial by Alexander Dominicus
09.12.2022
The S&P 500 has outperformed the European STOXX Europe 600 (Net Return) EUR by more than 400% since the low point of the financial crisis in March 2009. The US stock market is ahead of Europe this year too, but there are signs of a catch-up emerging. European markets have performed distinctly better in recent months and there is good reason to believe the turnaround will last.
Europe has been through a difficult decade. After the banks survived the financial crisis, albeit with scars, the euro crisis ensued. The UK voted to leave the EU in 2016 and this year has brought the war in Ukraine, the highest rates of inflation since the introduction of the euro and concerns over energy supplies.
Despite all that, the Europeans have succeeded in managing their crises. Through determination and solidarity the faltering southern peripheral countries were helped back on to their feet. Even during the COVID-19 pandemic, Europe was united, and got back on a dynamic growth trajectory after the economic slump in 2020. This year, the continent acted quickly and with pragmatism both in providing aid to Ukraine and in supporting its citizens to soften the impact of higher energy costs.
The dependency on Russian gas has put European – in particular German – equity markets under considerable pressure over the course of the year. By taking decisive and pragmatic action, gas storage facilities across Europe were filled enough probably to secure gas supplies through the winter months and beyond. Europe wants to greatly reduce dependency on Russia in future and possibly even become independent of Russian gas supplies.
The challenges in Europe and its underperformance, especially relative to the US, have resulted in wide valuation differentials. In terms of the price-earnings ratio, the European equity market is trading at approximately 12x, the US market at roughly 17x. Also with regard to dividend yield, Europe, at 3.6% is much more attractive, whereas investors in the US have to settle for just 1.8%.
The interest rate environment is in Europe’s favour, as the ECB’s interest rate hikes have been much more moderate than the Fed’s, the consequence being that European companies are less affected by rising interest rates than their US counterparts. The same goes for consumers, who traditionally have higher debt in the US and could now have lost a great deal of purchasing power due to the sharp rise in interest rates.
The currency trend is also a plus point for Europe, as the weak euro makes exporting companies more competitive. In addition, revenue earned in foreign currency boosts foreign earnings.
The low valuations in Europe provide stock pickers in particular with promising opportunities, with even competitive and well-managed companies now being traded at bargain prices. The most promising stock market strategy in the long run is to buy well-managed, growing companies at attractive prices. But in most cases only when pessimism is high and scepticism prevails. This is currently the case in Europe, as many investors have turned their back on the continent; times just like these are usually the best moments to enter the market.
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