back
Details Cookies
International
Important margin product information

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs, FX or any of our other products work and whether you can afford to take the high risk of losing your money.

Cookie policy

This website uses cookies to offer you a better browsing experience by enabling, optimising and analysing site operations, as well as to provide personalised ad content and allow you to connect to social media. By choosing “Accept all” you consent to the use of cookies and the related processing of personal data. Select “Manage consent” to manage your consent preferences. You can change your preferences or retract your consent at any time via the cookie policy page. Please view our cookie policy here and our privacy policy here

background image background image background image

The case for European equity exposure

Charu Chanana 400x400
Charu Chanana

Market Strategist

Summary:  A better-than-expected growth outlook, along with the boost from China’s reopening as well as below average valuations, is supporting the case for an outperformance of European equities over their US peers this year. Risks remain from an escalation of war or an uneven recovery in China, but these could still present attractive buying opportunities given the structural advantage of higher exposure of tangible assets in the European indices. Rising deglobalisation and higher-for-longer interest rates only tilt the case more in favor of value-rich European stocks over their growth-heavy US peers.


After a decent run since the start of the year, the US equity indices are now in technical downtrends again. Fundamentally as well, the case for more rate hikes is getting stronger, and US equities will likely remain under pressure from higher yields. In addition, margin compression is clearly a theme that is picking up in Q4 earnings outcomes, and will likely weigh further on US equities.

We have often voiced the importance of a balanced portfolio and the advantages of adding commodities to portfolios as an inflation hedge. In addition, this year also brings an opportunity to diversify portfolios by spreading out your investment across geographies. While the S&P500 is up ~4% year to date, MSCI Europe has recorded gains of ~9%. Most gains have come from a very strong performance in France’s CAC 40 index which is up ~13% YTD and Euro Stoxx 50 is up ~12%.

Improving macro fundamentals

After wading through the energy crisis last year without significant damage, the leading indicators for Europe have continued to gain strength since the start of this year. Flash S&P PMIs for February reported this week saw services PMIs for the region climb back into expansion and manufacturing improved as well. Sentiment indicators also continue to turn positive with natural gas prices down over 60% from the December peak and more than 80% from the August peak, easing cost pressures for businesses. In addition, Europe is better positioned to enjoy the tailwinds of a China reopening compared to the US due to the closer trade relations. In essence, the European economy appears relatively more resilient compared to 2022 when a recession was priced in.

Potential earnings upside

Lower cost pressures due to the slide in energy prices has helped European companies deliver better-than-expected earnings in Q4. Banks have also reported stellar results and luxury brands have come back in focus with the expected rebound in Chinese demand. Euro Stoxx 600 companies have delivered an earnings growth of 8.5% in Q4 compared to earnings decline of 1.4% for the S&P 500 companies, as on February 23.

Improved outlook for Chinese demand and restrained energy prices continues to boost earnings outlook. Meanwhile, the European Central Bank is expected to continue hiking for now, but peak rates are seen at 3.5% compared to 5-5.50% for the US. Still, the potential for an upward re-pricing of the Fed path is higher than that for the ECB, suggesting a relatively lower drag on the valuation of European stocks.

Value vs. growth

The outperformance of the European stocks vs. the US recently has also been driven by the brighter outlook for value stocks such as financials and commodities in the current high inflation environment compared to the tech-heavy US indices. This marks the beginning of the reversal of the post-GFC outperformance trend of the growth-heavy US indices.

The higher composition of tangible sectors in the European economy brings a structural advantage over the US peers, as higher interest rates necessitate more productive investments. The pandemic and the war have also exposed the supply-side vulnerabilities, sparking a capex cycle focused on developing the real economy. This means investments are going further into the tangible economy in order to ensure resilient supply chains, energy and food security and a strong infrastructure and defence cycle. These emerging trends will mean a re-rating of European stocks.

Attractive valuations

Despite the recent run higher in European indices, the valuation still appears to be attractive. Euro Stoxx 600 is currently trading at 13.5x forward P/E compared to its 10-year average of 14.4x. It is also trading at a discount to S&P 500 which currently has a forward P/E of 18.1x. The difference in valuation can in part be attributed to different sector compositions, with the US index comprising of more tech and fewer value stocks like materials, industrials and financials. But even with sector adjusted weights, European stocks are still cheaper that their European peers. Dividend yield for the European index, currently at 3.6%, is also better than that of the S&P at 1.7%. With large outflows from the European markets last year due to fears of energy shortages and a possible recession, many investors still remain underweight European equities and the room for catch-up is still seen.

SXXP Index STOXX Europe 600 Pri 20230223 145634

Risks ahead

Key risks for European stocks could come from a fresh surge in energy issues due to an escalation of the war in Ukraine. An uneven recovery in China could also turn the European growth outlook to be more muted ahead. The weakness in EUR, possibly accelerated by a very hawkish Federal Reserve or even a rapid increase in global recession concerns spurring safe have inflows into the US dollar, could deteriorate returns generate from European assets.

Market implications

Given the above factors, a broad exposure to European indices or ETFs with downside protection looks enticing. As more and more investors consider diversifying away from pure US equity exposures, the valuation gap of European indices to that of their US peers could close. If near-term risks escalate, that could bring some even more attractive buying opportunities in European stocks to position for the revival of the physical world over the intangibles. Anything from German industrials to French luxury remain attractive, given their direct benefit from China’s reopening. European defense stocks also remain a key hedge against a rapidly deglobalizing world, while semiconductors and energy have massive investments going in which are aligned with the political priorities as well.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.