Is Europe the hidden investment story of the recovery?
Lower rate of new Covid-19 infections and political unity in the EU drive optimism in the stock market
The past century or so has been tough on Europe. The continent is in long-term decline, relative to younger, emerging countries such as China and India.
Europe’s share of global gross domestic product has been shrinking for decades. In 1960, countries currently in the European Union accounted for more than a third of global GDP. That is set to fall below 10 per cent by the end of this century, according to the Pardee Center at the University of Denver.
Europe may still boast the world’s biggest single market in the EU, but that will shrink at the end of this year, when a disgruntled UK completes Brexit, with or without a deal.
Although the longer-run fiscal outlook remains challenging in southern Europe, the euro area fiscal position looks more favourable than in the US
Benjamin Segal, Neuberger Berman
Wrangles over the pace and extent of political and economic union will continue, as northern creditor countries the Netherlands, Finland, Austria and Germany – collectively known as the “frugal four” – resist debt sharing with troubled southern countries such as Italy and Spain.
The Austrian Empire, France, Prussia and the UK were once collectively known as the “great powers”, but nobody would describe them as that any longer. Germany is still the world’s fourth-biggest economy, after the US, China and Japan, but that’s as good as it gets.
This decline is reflected in its stock market performance. Over the past 10 years, the USA MSCI Index shows average annual growth of 13.98 per cent, which makes MSCI Europe Index’s annual 4.76 per cent growth look feeble.
Who would invest in a continent like this? Actually, there may be good reasons to put some of your money into Europe today, as it is putting aside its troubles to recover from the pandemic faster than many parts of the world, notably the US.
Benjamin Segal, senior portfolio manager and global equity specialist at fund manager Neuberger Berman, says European stocks started swinging back into favour since mid-May, and is optimistic that this can continue for the rest of the year, and possibly beyond. “Europe is ahead of the US in controlling the virus, as new infection rates remain relatively low, despite local flare-ups,” he says.
European GDP has inevitably plunged in the pandemic, but the US finds itself in a far worse situation.
In the second quarter, the US economy shrank by an astonishing 32.9 per cent compared with the same period last year, more than double the 15 per cent year-on-year drop in Europe.
The European Central Bank now expects activity to recover strongly in the third quarter, as the continent opens up faster.
Paradoxically, the crisis may have bought the EU closer together. Last month, EU leaders agreed on a €750 billion (Dh3.25 trillion) Covid-19 recovery effort, alongside a €1.07tn long-term EU budget for 2021 to 2027.
Many saw this as a step towards a stronger, closer eurozone, as it will involve a degree of fiscal risk sharing and central debt issuance, despite opposition by Dutch Prime Minister Mark Rutte.
Mr Segal says this should significantly reduce the risk of any further fracturing of the single market after the UK leaves on December 31. “Although the longer-run fiscal outlook remains challenging in southern Europe, the euro area fiscal position looks more favourable than in the US.”
This renewed optimism has helped to fuel a resurgence in the European single currency. At the height of the crisis on March 23, the euro was as low as $1.07. It has since jumped more than 10 per cent to almost $1.18 at time of writing.
Mr Segal believes the euro will maintain its strength against the dollar, as the US faces political volatility ahead of its Presidential election on November 3.
Patrik Lang, head of equities and global equity strategy at Julius Baer, says the euro could climb as high as $1.20 over the next year, as monetary union has been secured, at least “for the time being”. “The agreement increases the creditworthiness of all member states and a revival of an EU debt crisis like the one we saw in 2012 has become less likely.”
Mr Lang still expects to see faster growth in the US, driven by its buoyant technology sector that boasts global giants such as Apple, Amazon, Facebook, Microsoft and Google-owner Alphabet. “Current stronger profit performance in Europe is mainly due to its handling of the Covid-19 infection cycles and may only be temporary in nature.”
Current stronger profit performance in Europe is mainly due to its handling of the Covid-19 infection cycles and may only be temporary in nature
Patrik Lang, Julius Baer
Arnab Das, global macro strategist for EMEA at Invesco, says the EU’s monetary and fiscal policy is more proactive than in the past. “It has stronger growth-supportive policies than in China, and has managed the pandemic better than the US and UK.”
More importantly, the EU is now pushing for “ever deeper union” through its Next Generation EU package of reforms and financing.
Maurice Gravier, chief investment officer at Emirates NBD, says European stock markets have underperformed rivals such as the US for a good reason because company earnings growth has consistently lagged. “The continent has been unable to create any internet giant, its domestic economy is barely growing and share buy-backs have been much lower too.”
Rule out the notion that Europe can play catch up with the US, there are good, solid reasons why it has fallen behind. “Let’s face it, the growth differential will not go away anytime soon,” says Mr Gravier.
Mr Gravier says while the pandemic may have strengthened EU political unity, thanks to the emergency package, the euro revival may actually act as a “headwind on competitiveness and profits” among European companies.
You can invest in Europe using a low-cost, index tracking exchange-traded fund (ETF), either one investing in a spread of companies across the continent, such as Vanguard FTSE Developed Europe ex UK UCITS ETF, iShares MSCI Europe ex-UK GBP Hedged UCITS ETF or for variation, db x-trackers MSCI Europe Small Cap.
Alternatively, you can invest in individual countries through BlackRock’s iShares range, for example iShares MSCI Germany ETF, iShares MSCI France ETF, and so on.
Mr Gravier says while ETFs can work well in other parts of the world, they may prove less successful in Europe. “Don’t look at Europe as a homogeneous area such as the US, Japan or China where investing in an index makes sense, because it doesn’t.”
In this case, investing isn't about picking the best region, but the best companies. “Fortunately, Europe is home to fantastic companies, with solid balance-sheets and impeccable governance,” says Mr Gravier.
As an example, three of Europe’s most valuable companies hail from one of its smallest countries, Switzerland: food and beverage firm Nestlé, and pharmaceutical companies Novartis and Roche Group. The country is also home to financial services firms Zurich Insurance Group, Credit Suisse and UBS.
Mr Gravier says investors need to “pick the gems”, notably European global leaders in the healthcare, consumer staples and luxury sectors, as well as energy and financial services. “Buy individual companies or to trust the selection of a global actively managed portfolio with a focus on quality and sustainability.”
Don’t look at Europe as a homogeneous area such as the US, Japan or China where investing in an index makes sense, because it doesn’t
Maurice Gravier, Emirates NBD
France boasts financial services companies Axa, BNP Paribas and Société Général, retailer Carrefour, telecoms firm Orange, pharmaceutical firm Sanofi, carmaker Renault and cosmetics firm L’Oréal.
Germany has energy giant E.ON, as well as pharmaceutical firm Bayer, Siemens, Bosch, chemicals firm BASF and, of course, car makers Daimler, BMW and Volkswagen.
Investing in individual companies is always risky, no matter how prestigious the name. Many will prefer to spread risk with the right ETF or actively managed fund instead.
Popular names include Fidelity European, which has grown 60 per cent over five years, and gives you exposure to the likes of LVMH Moet Hennessy Louis Vuitton, Sanofi, Danish pharmaceutical firm Novo Nordisk, French energy firm Total, as well as Nestlé and Roche.
Or you might consider funds such as Invesco European Growth or BlackRock European Dynamic.
Europe isn’t about to spectacularly reverse its long-term decline, but it isn’t going away either. The continent still boasts some of the world’s most attractive stocks.
Published: August 17, 2020 09:30 AM