For European Stocks Four Months of Glory Is Not End of the Story

(Bloomberg) — It’s getting harder to argue the bull case for Europe Inc., yet that’s just what stalwarts at some of the world’s largest banks are doing.

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The region’s stocks have just ended a four-month streak of outperformance over the S&P 500 — the longest since 2012. Even so, strategists at Goldman Sachs Group Inc., Deutsche Bank AG and JPMorgan Asset Management are sticking to their guns, arguing Europe’s better value and still-strong earnings outweigh risks stemming from recession and higher borrowing costs.

“European equities still screen cheap and we expect another 5% upside,” said Maximilian Uleer, senior strategist at Deutsche Bank Research, citing among other factors, the potential for positive earnings surprises and Europe’s capacity to capitalize on stronger Chinese growth.

There is some evidence to back up Uleer’s view — LVMH this week reported soaring Chinese sales as shoppers emerging from lockdowns splurged on luxury items. That propelled it into the ranks of the 10 biggest global conglomerates. At least four other major companies — Novo Nordisk A/S, BASF SE, Volvo AB and Hermes SE have issued bullish earnings updates.

But bets on Europe were more abundant back in January, on conviction that cyclical industries such as industrials and banking would benefit handsomely from China’s post-Covid reopening and a softer landing for developed economies.

A few months on, the concentration of economically-sensitive industries may seem like a liability. The International Monetary Fund has trimmed global growth projections, including slashing euro-area forecasts to 0.8% for 2023 from the previous 3.5%. What’s more, central banks in Britain and the euro zone, unlike their US counterpart, have little scope to cut interest rates as growth slows. That’s creating another headache for companies — euro and pound strength.

No wonder then that returns on Europe’s Stoxx 600 lagged the S&P 500 in March for the first time since October. Investors have pulled over $1 billion European equities over the past five weeks, while channeling about $5 billion to the US, Bank of America Corp. says, citing EPFR Global data.

Still, the reversal is not complete. So far in April, the Stoxx is again outperforming Wall Street, enjoying a four-week rising streak. Surging luxury shares have lifted France’s CAC 40 index to a record, while an index of 50 blue European chips stands just off a 2007 high. In coming months, European and other international stocks should outperform expensive US tech as recession nears in the world’s largest economy, Bank of America Corp. strategist Michael Hartnett predicts.

Bulls remain

Europe fans will note it is one of the few regions globally where company earnings are not seeing net downward revisions, according to Citigroup Inc. analysts. Instead, it’s seen upgrades across 12% of its companies.

Share prices don’t reflect that though. True, mining and energy stocks usually trade at less exalted multiples than Wall Street’s glamorous tech firms. Even then, many consider valuations are unjustifiably cheap — at 13.4 times forward earnings, the Stoxx trades below its 20-year average and its 30% discount to the S&P 500 is almost the widest on record.

But the perception of Europe as a bastion of old economy stocks may be getting outdated. The Stoxx 600 isn’t as rich as Wall Street in software, social media and streaming services stocks, but Peter Oppenheimer, chief global equity strategist at Goldman Sachs, argues its changing structure is not sufficiently appreciated.

Two decades ago, telecoms and energy dominated Europe’s top 10 companies. Today the list contains luxury groups such as LVMH SE and Hermes, alongside Nestle SA, chipmaker ASML and drugmaker Novo Nordisk. Such high-quality names with international revenue streams and strong pricing power now comprise a quarter of Europe’s market capitalization, Oppenheimer notes, drawing parallels with US tech.

Karen Ward, chief EMEA strategist at JPMorgan Asset Management, says investors should also pay attention to the European Union’s game-changing €800 billion pandemic recovery fund. Agreed in 2020, the program is already disbursing huge amounts to support EU economies.

“The equity market hasn’t realised that Europe has got its mojo back,” Ward said, calling the fund the “biggest step forward in the institutional architecture of Europe in decades.”