Valuation discount keeps investors interested
Despite the rallies, valuations still appear to favour European markets over their frothy US counterparts. The Eurostoxx 50 index of eurozone bluechips trades at a forward price/earnings (P/E) ratio of just 16, while the Dax commands a multiple of 19 times earnings. Compare that to the S&P 500 at 25 times earnings and richly-valued Nasdaq 100 at 30 times profits.
The relatively cheap valuations help explain the strong investor inflows European markets are experiencing. Data shows index-tracking funds focused on European equities saw inflows of 45.7 billion euros in Q4 2023, up a staggering 45% from a year earlier as funds piled into the region.
The Bank of America’s closely-watched fund manager survey indicated professional investors were net buyers of eurozone stocks in February. However, despite the positive momentum, allocations to Europe still remain underweight relative to historical averages – leaving the door open for even more money to potentially flow into the region ahead.
What is driving the newfound appetite for European stocks?
Strategists point to several key factors that should continue supporting further upside.
Firstly, the European Central Bank (ECB) and Federal Reserve (Fed) are expected to start cutting interest rates later in 2024 as inflation pressures moderate after last year’s aggressive hiking cycle. Easier monetary policy has typically provided a tailwind for equity markets.
Secondly, while European growth is projected to be subdued, leading economic indicators are starting to recover from the slowdown. Signs that the worst of the downturn may be behind us is helping fuel optimism.
Critically, corporate earnings in Europe also appear to be nearing an inflection point. After a prolonged squeeze from high costs and lacklustre demand, analysts forecast earnings will trough in the first half of 2024 before positive revisions take hold later in the year as the economy firms up.
The sectors viewed as most likely to benefit from the turning earnings tide include software, aerospace/defence, semiconductors, diversified financials, pharmaceuticals and telecoms according to Morgan Stanley’s research team.
Their bullish outlook draws parallels to past economic “soft landing” cycles like the mid-1990s environment, which saw mixed data paradoxically drive markets higher. Weaker figures bolstered hopes for rate cuts to stimulate growth, while stronger numbers pointed to an emerging recovery taking hold.
Short-term risks remain
Of course, risks remain that could throw European markets off course. Geopolitical tensions are more heightened today versus the relatively stable backdrop of the 1990s. Persistent supply chain disruptions also represent a potential headwind that was not a major factor during that prior period.
But for now, relatively attractive valuations, a positive earnings outlook, rebounding economic data and prospects for easier monetary policy appear to be powerful catalysts propelling the long-awaited rotation into European equities. If the current momentum persists, we may just be in the early innings of the region’s next great bull market after over a decade of underperformance.
