European equities have gained more than 20% since their September 2022 lows and at the moment, it maintains an uptrend that few investors expected and few managed to capitalize on. The overly cautious positioning in Europe was due to recession fears.
However, now that the contraction – with an impact on unemployment – is slow in coming, investors are wondering what attitude to adopt. The search for opportunities will be crucial in the second half of 2023. Some experts are convinced that strategies should continue to focus on quality values because they will maintain the good momentum of your business in the current scenario.
Europe has also witnessed the artificial intelligence craze, but market rises have been more spread than in the United States. Only 25% of S&P 500 stocks have performed better, compared to more than 40% for the Stoxx 600, a sign of the depth of the European market. Europe’s least concentrated profitability should be used to identify opportunities.
Multiples contracted sharply due to rate hikes in 2022 and, despite recent strong performance, European markets are still trading at a very reasonable P/E ratio of 12.5 times, below the historical average of 15 times in 10 years, and at a 20% discount to US equities (based on equal sector weights).
“Assuming that most rate hikes have already passed and that equity valuations are more closely related to the extent of rate hikes than to the final rate, we at Edmond de Rothschild AM believe that there is now little chance of further compression of multiples,” analyses Caroline Gauthier, co-head of equities at Edmond de Rothschild AM. On the contrary, the expansion of multiples is a real possibility.
Even after the rebound in the first half and despite persistent macroeconomic uncertainties, European markets appear to be protected by subdued valuations and the fact that investors are generally underweight. Leaving aside the question of a recession and its severity, it is clear that the old continent is in a period of economic normalization with a slowdown in activity.
“The shortage is not over yet and demand could weaken at some point. That is why it remains essential to be vigilant and invest in companies with strong economic models and healthy balance sheets that offer greater visibility,” adds Gauthier.
The trend can continue
Similarly, according to Lara Pellini, equity manager at Capital Group, consumers have continued to spend their money, travel and tourism have rebounded and European companies “benefit from the moderate growth of national economies and international opportunities”, including “the reopening of the Chinese economy”.
In fact, some of Europe’s most successful multinationals are very adept at tapping into external revenue streams from Asia, Latin America or the United States. “For example, Novo Nordisk’s weight-loss drug, Wegovy, has seen huge demand worldwide, which has seen the Danish company almost double its sales forecasts compared to 2019,” he says.
In Europe, certain companies can grow even in difficult economic environments, pointing out the importance of bottom-up fundamental analysis. “In the luxury goods sector, many of the major brands are located in Europe, but their customers are spread all over the world. LVMH, the French luxury giant, recorded record revenues of $86 billion in 2022, thanks mostly to strong demand from the United States and Japan.
Pellini says one reason these companies have the potential to outperform domestic rivals is that their competition is international, which can boost innovation. “The competitive advantages they develop are very difficult to replicate,” he says.
Similarly, small caps have been scorned by investors and the sector was particularly hard hit last year, underperforming large caps by an unprecedented margin, and even more than ever.during the 2008 financial crisis. “Driven by risk aversion and the flight to liquidity, this extremely low return has led to the biggest valuation anomaly of the last 20 years,” Gauthier said.
Over the past 20 years, these companies have traded at an average premium of 25% to large-caps. With earnings in 2023 and 2024 expected to once again outperform those of large-caps, a simple return to historical premium levels would mean a 35% increase.
“Given that the leverage among small caps is not higher than that of large ones, and for a volatility similar to 20 years, these represent a very interesting risk/return profile for a medium-term investment,” concludes the expert from Edmond de Rothschild AM.
