Han Dieperink: Europapa

April 2, 2024

^{This column was originally written in Dutch. This is an English translation.}

By Han Dieperink, written in a personal capacity

After the strong rise of the US stock market, investors are looking for possible alternatives. Europe is an obvious option.

Europe is structurally much weaker than the United States. That is an important reason why European shares deserve a discount compared to American shares. However, European shares are much more sensitive to the development of the global economy. That is welcome news now that growth expectations at the top continue to surprise. Moreover, persistently high inflation in Europe has been a problem for a long time. However, now that inflation figures are better in Europe as well, the chance of multiple interest rate cuts in the short term increases. Moreover, much of the bad news has been discounted in the prices.

Appreciation of Europe lagging behind

The Eurostoxx 50 index now trades at around 14 times earnings. Italy's FTSE MIB just broke a 16-year high, helped by ECB protection, increased M&A activity and modestly improving earnings performance. Just like in the United States, the rally is also gaining broader support in Europe.

Within Europe there is still an important choice that investors have to make: to invest in the eurozone or beyond. Half of Europe consists of eurozone countries, but the other half (United Kingdom, Switzerland and Norway) is just as interesting. Thanks to Brexit, the British stock market is even cheaper than the European stock market and has a relatively large bias towards commodities and financials.

Europe has more cyclical sectors

In March, the European stock market outperformed the US stock market for the first time in a long time. This is partly a consequence of the sector division. While in the United States the emphasis is on IT and growth sectors, in Europe the emphasis is more on cyclical sectors. This already includes a relatively large amount of pain.

Many cyclical stocks have lagged as a recession was forecast both last year and this year. A recession that has become increasingly unlikely to materialize anytime soon. It also appears that the cycle has hit a bottom in Germany now that unemployment is no longer rising. In Germany there was probably a technical recession due to cautious consumers, weak external demand and high interest costs.

Money flow towards Europe

Hedge funds are now 5.8% overweight in European shares for the first time in a long time. The number of shorts has also fallen sharply in a short time to 0.2% of the market capitalization. That percentage has not been so low in the past ten years. Furthermore, American investors want to invest more outside the US due to the increased prices in the US. The situation surrounding the American presidential elections may also be seen by many Americans as a possible risk for the American stock market.

A problem for the eurozone is that the Union is not complete, which is a risk for the long-term survival of the euro. The advantage, however, is that the European Union is first and foremost a political union. The will to work together for a 'never-again war' scenario is great and is fueled by the battle in Ukraine. That also helps the Dutch chances for the Eurovision Song Contest. Certainly the European countries on Europe's eastern border have become more pro-NATO and pro-Europe.

Long European underperformance

European equities have lagged behind US equities for almost 20 years. The tipping point was during the Great Financial Crisis. After that, expectations for American shares were not high, while the crisis mainly caused problems in Europe.

First of all, American mortgage bonds were the most important export product of the American economy at the beginning of this century. Due to the low profitability of many European financials, they had turned to this new source of returns. That was a prelude to the euro crisis. This may have been caused by Greece, but European banks could not bear the Greek losses because balance sheets had already been weakened by the write-downs on the aforementioned mortgage bonds.

Extensive financial sector

The fact that Europe was hit so hard in the Great Financial Crisis is also due to the size of the financial sector. While the Fed already sounded in December that there was room for three interest rate cuts, the ECB was more cautious for a long time, a direct result of the persistently high inflation in the eurozone.

Now that inflation figures are better than expected, there suddenly appears to be room for as many as four interest rate cuts in the eurozone this year. The European housing market is also financed differently than the American one. While many Americans still benefit from extremely low mortgage rates despite the increased interest rates, European homeowners feel the increased interest rates much more. Now that interest rates are going to fall, this will have little effect on American spending, but all the more on European spending.

Restore real wage development

The much higher inflation in the eurozone was mainly a result of the sharp increase in energy prices. Wage development lagged behind this increase for a long time, but higher wage demands are now ensuring, with a delay, that consumers in Europe are also improving in real terms. Now it will take some time for consumers to get used to this, because they will feel for a long time that prices have risen much faster than wages in recent years. That may also be the reason why European consumers are saving more.

Vanishing industry

The biggest problem for Europe in recent years has been that, due to high energy prices in combination with high wages, many industries no longer see a future in Europe. The contraction that started a few years ago continued for a long time. We have probably lost part of the industry forever.

At the same time, the situation in European industry is now starting to stabilize. It helps that China is now doing more to get its economy back on track. Europe is much more dependent on China than the US is. Things are gradually getting less bad in Europe in several areas, while the perception has been very negative for a long time. Then there is room for catching up in terms of price.

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