It has been a good period for European equity markets, despite ongoing volatility. Stefan Gries, manager of the BlackRock Greater Europe investment trust, discusses the region’s prospects for the remainder of 2023.
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Against expectations, European stock markets have outpaced their international peers since the start of the year.1 It marks a significant change in investor confidence from 2022, when Europe appeared to be facing a potential energy crisis, slumping consumer and economic confidence and rising inflation.
Many of the 2022 challenges have started to fade. Both macroeconomic data as well as fundamental data have surprised with their strength: the region has side-stepped an energy crisis, leading to lower Eurozone inflation numbers. At the same time employment has remained robust, and many European companies are expected to benefit from China exiting its Zero Covid policy.
While economic data remains mixed, with first quarter GDP growth for the Eurozone of just 0.1%,2 the consumer has shown better resilience than expected, even with higher energy and food costs weighing on household spending. Importantly we believe the majority of rate hikes are in the past.
Earnings strength
While this is encouraging, on the BlackRock Greater Europe Investment Trust, we have never believed that a strong Eurozone economy is necessary for stock market progress. Many of Europe’s largest companies draw their revenues from across the globe. The luxury goods sector, for example, has been a significant beneficiary of China’s reopening.3Plus, those companies geared to structural growth trends – digitisation, green spending - can transcend economic weakness.
As a result, the bottom-up picture for the corporate sector remains robust. Earnings haven’t been nearly as bad as expected, with many companies delivering stronger earnings in their recent updates, defying the market’s gloomy expectations. Corporates have adapted to higher input costs and overcome many of their challenges much better and more quickly than anticipated. Overall, there has been a broad-based strength in earnings with upgrades coming through across different areas of the market and across different sectors.
Low expectations
The region has also benefited from low expectations. Market valuations suggested investors believed a recession was imminent and that companies would deliver little or no earnings growth. In particular, markets had been tentatively predicting an energy crisis, with the resulting impact on manufacturing activity. The energy crisis did not materialise, as policymakers and companies scrambled to find other sources of energy and a mild winter reduced demand.4
The financial system has also been resilient. Despite the Credit Suisse debacle, European banks have generally not seen a similar credit crunch to that experienced in the US regional banking sector. There have been assurances from central bankers and regulators on the sector’s financial health, helping to restore some confidence. This has supported lending in the real economy.
Long term lens
However, while these factors have revived European markets in the short-term, we believe investors need to align themselves with long-term structural growth themes to sidestep any economic uncertainty in the year ahead. European economies have yet to digest the full impact of higher interest rates, and inflation is not yet back in the box. As investors, we need to find companies that can thrive in all market conditions.
Our portfolio focuses on a number of key areas. The first is green spending, which incorporates companies involved in digitialisation, electrification and decarbonisation. This has been a major long-term theme for the trust, and has been turbo-charged by initiatives such as RePower EU, the Green Deal Industrial Plan (the EU’s response to US Inflation Reduction Act).
We are also looking at companies that could be beneficiaries of the energy price decline. Companies are seeing falling pressure on costs, while consumers are also likely to benefit from lower energy bills. This may prompt some improvement in consumer spending. This is balanced, to some extent, by select holdings in European banks, which are beneficiaries of higher rates.
A resurgent China, newly opened after the lifting of the zero Covid policy, is also providing a boost for certain European companies. We would highlight luxury goods companies, such as Hermes and LVMH, which have also benefited from strength in European and Japanese tourism. Semiconductors may also benefit from the revival in China as the country’s electronics and auto industries see activity levels rise.
While there remain a number of unknowns from an economic perspective, corporate balance sheets are in decent shape, particularly compared to previous downturns. Many companies in Europe have spent the last decade reducing debt and are much less vulnerable than during the Global Financial Crisis. Equally, long-term structural trends and large amounts of fiscal spending via the Recovery fund, Green Deal and the REPowerEU plan in Europe can drive demand in specific sectors for years to come. This is where we are hunting for opportunities.
Sources:
1 https://www.msci.com/documents/10199/db217f4c-cc8c-4e21-9fac-60eb6a47faf0 MSCI - 09/06/2023
2 https://ec.europa.eu/eurostat/documents/2995521/16349868/2-28042023-AP-EN.pdf/3c13b9fc-9526-2f0a-b094-bac5cbb8c2cb#:~:text=In%20the%20first%20quarter%20of,office%20of%20the%20European%20Union. EC – 20/06/23
3 https://www.investorschronicle.co.uk/news/2023/04/19/luxury-brands-revel-in-china-s-reopening/ IC – 19/04/23
4 https://www.iea.org/commentaries/europe-s-energy-crisis-what-factors-drove-the-record-fall-in-natural-gas-demand-in-2022 IEA - 14/03/23
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