The table above shows the changes in sector weights for S&P 500 and STOXX 600 since December 2007. While the collapse in the US energy sector has been significant it has been outweighed by the rise in technology (Microsoft and Apple), consumer discretionary (Amazon) and communications (Facebook and Alphabet). The biggest losing sector in Europe has been the financials which were dominant in 2007, but is still the largest sector, but has since lost its profitability as the Euro crisis and wrong policies have made it difficult to operate banks. Europe’s two biggest winners have been health care stocks and consumer staples and here lies some of the future potential.
What is the case for being positive and overweight European equities? Valuation is much better on European equities with a forward dividend yield of 2.8% and dividend futures expecting annualized dividend growth of 0.6% until 2023. On top of that the P/E multiple is lower on European equities relative to US equities so European equities could get a relative better P/E multiple over the coming years. US equities are currently priced with a forward dividend yield of 1.7% and dividend futures expecting negative 3.3% annualized dividend growth until 2023. This means that US equities need P/E multiple expansion much more than European equities to continue to deliver outperformance. That’s going to be difficult.
In the case economic activity is subdued globally the coming years European equities offer more defensive characteristics with a higher weight on consumer staples, health care and utilities. Europe is leading on the green transformation and here lies another upside through the industrials and utilities sectors. With only 7.5% of European equities in the technology sector there’s also room for a higher weight over time which will improve the growth profile of European equity markets. Finally with Europe’s large health care share and the increased focus on drug discovery and health care equipment after COVID-19 Europe does have an edge.On the macro side a weaker USD, which is urgently needed by many countries, would add tailwind for non-US equities. Europe’s potential fiscal integration with the EU Commission issuing joint debt has the potential to solve some of Europe’s structural issues which also could be a positive for European equities. Increasing technology regulation could also increase costs for US technology companies and thus act as a drag on US equities.