Europe, the struggling candidate – time for the pole-position, finally?
15 July 2024
Valuations for European equities look attractive
Short-term: not the brightest picture for the economy
- Leading indicators: recessionary scenario
- ECB: in an uncomfortable situation
- Upcoming trading war with ChinaFragile base and impact by long-term factors
- Politics
- (Over)regulations
- Missed out innovation trends, especially in the tech sector
- Culture and mentalityMy Portfolio: allocation to European equities: yes, but…
How fragile and prone for setbacks the European markets are, could recently be observed. The results of the European elections in the beginning of June followed by the call of re-elections from the French president Emanuel Macron in his country, led to turmoil on equity and bond markets and the euro currency. The Euro and European stock markets were tumbling, losing heavily ground in no time, hitting French equities the most. So far, European indices did not recover well from these levels. During the last days, European indices were often seen in the red, while US indices pointed to the green, upside.
The French stock index, the CAC40 Index, containing the biggest 40 listed companies, could clearly gain ground since end October 2023, benefitting from the overall market rally led by the US tech stocks. Since March 2024, the index started a sideways trend and clearly lost ground with the European election taking place on the weekend from the 6 to 9th June.
CAC 40 Index - French Equity Index
1 Year as of 15 July 2024
Source: TradingView 15.07.2024
While the French stocks did not recover yet, the leading European index, the EURO STOXX 50 Index, containing the 50 biggest listed companies in the Eurozone, did a bit better. However, it seems that the index does not get the momentum to overcome the April highs at this point and therefor could remain in its sideways trend for some while.
EURO STOXX 50 Index
1 Year as of 15 July 2024
Source: TradingView 15.07.024
Attractive valuations on first sight
Even before this set-back, European equities already looked pretty attractive on a first sight with valuations on rather lower levels since some time already. Compared to the valuations in the US, there is a big gap and we should think that there could be a nice catch-up potential, in case the up-trend on the markets should continue. However, this gap exists already for a longer period and, in my view, will not going to be closed, in a longer-term perspective.
It is already a long time ago, during my earlier stages of investment experience, I personally believed that this valuation gap compared to the US could have chances to be closed sooner or later. However, since years already, I have my doubts that there is this upside and catch-up potential for European stock markets compared to other regions due to many reasons. With the latest sell-off, these doubts will remain. Of course, there will be a certain rebound potential, however rather limited compared to other indices like in the US.
Before this political events, European stocks seemed to do quite well. Important to notice here is the dividend season usually taking place in the second quarter when most European companies pay their dividends once a year. Compared to the US, where companies pay their dividends on a quarterly basis.
Dividend returns are for example reflected in the German Dax Index. In the Swiss Market Index SMI, dividend yields are not added to the index. This means, the German Dax adds already a performance about 2 to 3% within the second quarter, only by the dividend payments by its the index members.
Short-term factors dragging down
Economy: Leading indicators not drawing a bright picture
The Purchase Manager Indices (PMI) in most European countries are clearly below the 50 threshold. A level of the PMI above 50 means that an expansion of the economy can be expected while a number below 50 means contraction.
Therefore, the European manufacturing sector remains in a rather contraction cycle and will not head into a growing phase the coming months.
Even showed in my article “Sky is the limit – Big Tech and negative News run the show” on 18 June 2024, the regional Economic Surprise Index is pointing a bit to the upside. Means latest data starts to surprise rather to the upside, however, only slowly and remaining on a low and subdued level.
ECB – an uncomfortable, lose-lose situation
How should the ECB react on these circumstances. Was the recent rate cut too late? Based on economic data, the answer could be rather yes, as the economy might need more support from a lower interest rate environment. Based on the inflation figures, the answer would then be rather no. The market expects the ECB to further cut rates to support the economy. However, the inflation level is not back to the 2% target yet. Should interest rates be cut too early, the inflation could get a new boost which is not in favor.
The US and the US central bank Fed has a much better stance. There is no need and pressure to reduce interest rates as the economy seems to run on high level.
Long-term Factors dragging
Fragile base: Politics - (Over)regulations - big miss of the Tech trend
Through the latest political events, we got well remembered of the overall instability the European leaders and their political system. We can also count UK to this club where elections took place two weekends ago with a clear shift in the parties. France with the re-elections and Germany with the political set-up which is struggling to make progress in any reforms since its election. In Italy, it has been quiet for a while. Maybe a question of time when this parliament is going to be called for re-elections as well.
Even it is said that political markets are short-lived, in Europe the political systems and set-up is not a supporting factor for the big successful stories and booming financial markets.
Mentality and Culture – a big drag
In my view the spirit and mix of the different European countries, their different cultures between the north and the south and the overall mentality is not a supportive factor for a booming economy, rather a drag and comes along with a lag in the economic potential. Willing to take risks is rather in a minority, cautious stance rather in majority. I personally believe, that this factor is also a reason, why the Tech evolution cycle has been clearly missed in Europe. How many European tech names do you know? How many US names get in your mind?
The structure of the European Union and all its regulations are not supportive either. Let’s call it rather overregulation which, in my view became and big drag for future economic growth. This factor will remain going forward.
Trading war
It seems that Europe has the risk of entering a trading war cycle with China. To take a defensive stance for the own running industries, like the important car producers in Germany, EU regulators started to put an eye on Chinese electronic vehicle (EV) imports to set up new tariffs. They are just about to flood the European markets with cheaper EV models. In China, the sector and corporates were heavily subsidized by the government in their innovation and production cycle over the last years. The reason, why the Chinese corporates like BYD can now offer their models on a much cheaper price level compared to the German car dealers.
A sign that the EU is clearly afraid about these additional competitors and shows the willingness to protect markets for the own industry by establishing tariffs on imports.
Another option could be to support and push the own industry by supportive regulations and framework, which is not the case.
Usually, such a potential trade war could rather hit back and negative consequences could be expected should the Chinese join this race from their side. Chinese regulators already announced potential tariffs from their side.
Even European markets are showing attractive valuations, the overall big picture in European region does not have the conditions for a boom market according to my comments above.
What is the implication and how is this reflected in my investment strategy and decisions?
My Portfolio
Even European stocks show a rather attractive valuation since some time already, I did waive having big allocation to this region, excluding Switzerland, UK market and some Scandinavian countries.
Overall, there is a certain allocation to European/Euro area stocks in my portfolio. I invested mainly in quality stocks with attractive valuation or dividend yields with a buy and hold strategy. The banking crises in March 2023 was taken as an opportunity to increase the allocation at a certain point. The strategy is mainly implemented via ETFs (Dividend, Value and Banks). In addition, the portfolio consists of some single stocks, mainly with a buy and hold strategy as well.
Political markets are said to be short-lived. Therefore, we could think that latest set-backs can be taken as chance to add some allocation to European markets and buy some more quality stocks.
However, first I would like to see a correction or at least a consolidation of the overbought US markets, which normally will also affect European markets. Even after the recent correction caused by the political turmoil, European stocks look still vulnerable to me and would be dragged down in case of a US market correction.
And as a Swiss Franc investor, it is important to be aware of the currency risk. The euro has the potential of losing ground while there is a big chance that the Swiss franc continue to appreciate in its long-term trend.
The earning season, which is about to kick off, any upcoming inflation numbers and any central bank comments could overall give markets a short-term direction. Investors are just waiting (and hoping) for mor evidence for rate cuts. This could lead to more inflows to risky assets like equities in short-term nature.
The probability of a later rate cut and lower number in rate cuts in the US and also in Europe is quite high. This may lead to investors being disappointed and reducing their bets and risks within their portfolio.
As mentioned in my former articles, the rally and speculation are able to continue, however, can stop with any trigger on any day. Overbought markets are vulnerable for set-backs led by new uncertainties and therefore a bit of a cautious and not all-in stance makes sense to me. Let the markets run with your capital invested, be prepared for set-backs. Hold back with adding new risk positions in your portfolio for the moment.
Not to forget the race for US presidential election during the coming weeks till the election date in November, with events just reached new dimensions this weekend.
Disclosure of shares in my portfolio specifically mentioned in this article (as of 15 July 2024):
No specific disclosure as all holdings are mentioned in this article already