- Investment Strategy Analyst
Asset classes
Hong Kong (香港), Individual
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Despite talk of the “Trump trade” and persistent pessimism about the European economy, European equities have been having their moment in the sun, outperforming US equities since November. As illustrated by the infographic, this reversal has been mainly driven by Europe’s largest sector overweights, notably financials and industrials. European financials significantly outperformed their US counterparts, while US industrials remained flat. Overall, we have seen a strong upward trend in European companies revising their future earnings, which has translated into improved market expectations. As a result, performance has caught up.
For this positive momentum to last, investors need to believe that further market broadening will occur and that the geopolitical headwinds that challenge the continent will not exacerbate an already weak economic outlook. A lot remains uncertain, and we have a balanced view: fundamentals do not yet suggest a new era, but removal of some of the headwinds would go a long way in supporting European markets. In the meantime, we see continued opportunity for security selection.
Figure 1: Europe's sector returns outpace the US year to date
Investment implications
- Despite Europe’s recent outperformance, major constituents of the index still have some catching up to do over the longer term. Certain stalwarts of the European economy within these sectors such as autos, pharma and chemicals not only have a weak growth outlook but are also major exporters to the US. Allocation to higher conviction sectors instead of the broad index may address sector dispersion and US tariff risks.
- Regional growth and political developments may also be a driver of European stock dispersion. Financials have been the top performer of late, but French and Italian banking stocks were initially hit hard by last summer’s French political crisis. The UK still appears too susceptible to commodities/energy pricing, with politics and a challenging macroeconomic backdrop also weighing on sentiment.
- Increasing consensus within the euro area and the EU on economic and geopolitical matters could lead to wider-reaching policies that have greater impact on equities. Commitments to significantly boost defence spending (most notably, the announcement of a transformational spending package by the incoming German coalition and measures agreed upon at the recent EU defence summit); deregulation proposals; and coordinated investments in the energy transition are some of the potential growth beneficiaries resulting from a more unified Europe.
What we are watching
- The increasing likelihood of Ukraine peace/ceasefire negotiations. While the situation is still fluid, any outcome is likely to have substantial impact on European markets. Factors to watch include Europe’s reconstruction and defence spending obligations, changes to energy prices via any potential lifting of sanctions and how this would interact with already strained government budgets.
- Implementation of US tariffs on European markets. Trump’s calls for a “reciprocal” tariff policy and tendency for rapid deployment could take Europe by surprise, especially given its large trade surplus with the US. Vulnerability may vary by country and sector, with Europe’s largest auto and medical and pharma sectors most likely to be in the firing line.
- Political developments in Europe. France’s constitutional crisis last summer triggered market volatility, and the recent German elections also caused considerable angst among investors. For now, political upheaval in France has abated and the apparent speed at which German coalition discussion is progressing, combined with the scale of fiscal transformation and the potential for corporate tax rate cuts, are promising. “Pro-Europe” policies that seek to reduce dependence on the US and China and bolster growth are long overdue and would benefit European equities.
Chart in Focus: Can this equity bull market last?
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