After a year mired in political uncertainty and inflation, investors moved as far from European equities as they could in favour of the US. But while market volatility is by no means over – certainly not in the short-term – we are already seeing some return to European sectors.
There are viable reasons for this. Namely, that initially overlooked factors have begun to be noticed.
‘Effective policy coordination, joint debt issuance in the form of the Covid Recovery Fund, unity in the face of the war in Ukraine, and a dearth of countries attempting to follow the UK out of the European project may support the argument that while Europe is forged during crisis, its longevity and resilience is frequently underestimated,’ said Freddie Fuller, product specialist of European Equities at RBC BlueBay.
The market valuation has certainly risen from Q3 2022 lows but is still offering upside potential to our intrinsic fair value estimate. This, for us, shows that investors are not getting completely carried away and are still aware of the macroeconomic risks.
Michael Field
European equity strategist, Morningstar
His remarks were echoed by others. Vontobel Asset Management’s Daniel Kranson and Markus Hansen said: ‘In 2022, European investors faced many fears [but] recently, the situation reversed.
‘Energy prices reversed with Germany’s quick LNG buildout and nuclear review – helping consumer sentiment and lowering required government aid.
‘Energy access improved, aiding businesses. Inflation appears to have peaked. China reopening helps European exports. The war, unfortunately, continues; but direct NATO-Russia confrontation has been avoided.
‘These developments, combined with low valuation, pushed European equities higher.’
A European rally
The effects of the widespread recognition have rippled across markets: the Morningstar Europe Index experienced a 20% climb from its September 2022 lows. This is within ‘touching distance’ of the ‘all-time highs’ reached in September 2021, said Michael Field, European equity strategist at Morningstar.
But, he added, despite the recent rush, investors remain cautiously optimistic.
‘The market valuation has certainly risen from Q3 2022 lows but is still offering upside potential to our intrinsic fair value estimate. This, for us, shows that investors are not getting completely carried away and are still aware of the macroeconomic risks.’
Market cap-weighted price/fair value estimate for Morningstar Europe-domiciled coverage
He also said there are lots of opportunities around – especially in ‘exposed’ sectors such as consumer cyclicals and financial services.
Star rating distribution by sector
Surveying for dangers
With all the hype around market rallies, investors have to keep their guard. A rebound from low valuation is a ‘one-time’ benefit to shareholders, mentioned Kranson and Hansen. Longer-term equity performance, meanwhile, relies on earnings growth. Alas, European growth remains structurally low.
European stock rally compared to the US should not be over-interpreted. Given all the uncertainties – which are mainly driven by geopolitics and hence extremely difficult to predict – a worldwide-invested and truly diversified portfolio is probably a prudent choice for a long-term investor.
Tatjana Puhan Deputy CIO, TOBAM
The risks to equity markets are also aplenty. Inflation and interest rates are the big ones. With Europe on the brink of recession, rising interest rates could easily send us over the edge – and an unexpected escalation in the Russia-Ukraine war could just as easily tip the balance.
Tatjana Puhan, deputy CIO of TOBAM, warned: ‘European stock rally compared to the US should not be over-interpreted. Given all the uncertainties – which are mainly driven by geopolitics and hence extremely difficult to predict – a worldwide-invested and truly diversified portfolio is probably a prudent choice for a long-term investor.’
With all of this happening, it need not be said that 2023 will be an interesting year for European equities. One thing is for sure, however: Europe is not out of the woods yet.
