As Europe recovers from the pandemic and Brexit-related challenges, global investors' wariness about investing in the region is settling down. European stocks have lagged their U.S. and Chinese counterparts for a long time due to social and political issues and a delay in vaccine rollouts. However, now that Europe is settling down following the 2020 disturbances, equities appear quite cheap, with various options to invest in. This is in complete contrast to the situation in the United States, where stocks have already reached all-time highs following the market crash in early 2020.
Post-recession outlook for European equities
Following a weak start to the year due to ongoing lockdown measures, recent economic data from the eurozone suggests the recovery is gaining momentum. According to Goldman Sachs Group Inc. (GS, Financial), the majority of U.S. and Asian investors are putting some of their investable assets into European stocks due to cheap valuations. The economy is expected to enter a new phase of policy support in a post-pandemic environment, which will likely result in near-ideal conditions for European equity markets in the coming months. The majority of investment banks expect European stocks to outperform their U.S. counterparts for the rest of the year and well into 2022 based on current market trends.
Commenting on the growth in business activity, head of European equity strategy at Société Générale (XPAR:GLE, Financial) Roland Kaloyan said:
“We are still seeing a reactivation of European economies, and earnings this quarter are going to be great, with strong base effects given the weak position we were in this time last year.”
Purchasing Managers' Index readings in the eurozone hit new highs in June, indicating rapid expansion in business activity across the region, prompting foreign investors to become the largest owners of European equities. According to FactSet, companies included in the Stoxx 600 index are expected to report aggregate earnings growth of more than 50% in 2021 compared to the previous year. As a result, analysts at Morgan Stanley (MS, Financial) project Europe will beat all major regions from a stock market performance perspective this year. In a research note to clients, the analysts wrote:
“We think there is a good chance that Europe outperforms all major regions this year for the first time in a calendar year since 2000.”
Commenting on this trend, Chief European Equity strategist at Morgan Stanley, Graham Secker, said:
“With global investors structurally underweight Europe, there is ample scope for the recent run of inflows, which should be counted in weeks rather than months, to persist for considerably longer if the investment narrative remains attractive.”
According to Barclays PLC (BCS, Financial), the delayed reopening will benefit the region in the second half of the year as the focus will shift from curbing the spread of the pandemic to achieving real economic growth. In a recent note to clients, Emmanuel Cau, Barclays' head of European equity strategy, wrote:
“We believe the region’s positive economic momentum could carry on into 2022, as the private sector is eager to spend, banks emerge from the crisis in good shape and the fiscal stance is firmly pro-growth.”
Many institutional investors are turning bullish on European stocks, which is good news for this asset class as fund flows are likely to gain some momentum due to these positive remarks.
Sectors to look out for
The health crisis has forced companies in every corner of the world to shift the way they operate, and it is already evident that companies willing to make the necessary changes are likely to emerge as winners in the long run. In any case, the market performance will be heavily influenced by fiscal policy measures as well as the changing macroeconomic conditions.
Commenting on which sectors will benefit, UBS Chief European Economist Reinhard Cluse said in a recent interview:
“So the next three years I think is when we are likely to see the biggest payoff in terms of real economic activity, support for company earnings, particularly in sectors that have benefited from the recovery fund. These will be the capital goods space, utility companies, the auto companies, and also the telecom providers. In these sectors, we would expect the most meaningful payoff.”
Currently, value stocks are considered cheap and are likely to gain from a revival in the economy. Growth investors, on the other hand, have the opportunity to focus on the fast-growing tech space in Europe that is largely untouched by global investors. According to analysts at BNP Paribas SA (BNPQF, Financial), European banks, basic resources, autos and the energy industry should be prioritized by value investors when searching for attractive bets. European bond yields are already turning a corner to move higher, which paints a promising outlook for banks in this region.
Commenting on merger and acquisition deals executed by several European banks to increase their profitability, David Tomas, portfolio manager at Andbank Wealth Management, said:
“The tide is already high for the banking sector and all banks are up there, so now it’s a matter of being selective. Some banks will benefit from M&A.”
According to Frédérique Carrier, head of investment strategy at RBC Wealth Management, when bond yields rise, European stocks often gain because they are more exposed to the sectors that benefit from higher yields. Commenting on this, Carrier said in a recent interview:
“Europe is a global leader in industries geared towards the green economy, ranging from renewables operators and green transportation to electrification and industrial automation. Companies in the financials sector remain attractively valued, in our view, and are seeing positive consensus earnings revisions.”
The recovery of the economy will be a catalyst of growth for the e-commerce industry, luxury fashion industry and the cosmetics sector. The global luxury fashion market is already rebounding to pre-recession levels. Europe is widely considered the largest market for this industry, which makes it an ideal investment choice for growth investors looking for international exposure. The travel and leisure sector is also worth monitoring, but investors need to account for the possibility that travel will not recover to pre-recession levels even after the vaccination program is fully completed because of international travel restrictions and a fear among travelers that the pandemic might make a few more waves before coming to an end.
Takeaway
There is reasonable evidence to suggest European equities will deliver strong returns in the coming years. The macroeconomic environment is finally improving, valuations are attractive, earnings revisions are trending in the right direction and European governments are continuing to pump money into the economy. With this backdrop, investing in European stocks today seems a good bet on the recovery of the global economy.
