{"id":13585,"date":"2024-04-01T10:55:12","date_gmt":"2024-04-01T14:55:12","guid":{"rendered":"https:\/\/www.rbcwealthmanagement.com\/en-eu\/?p=13585"},"modified":"2024-04-01T10:58:39","modified_gmt":"2024-04-01T14:58:39","slug":"the-metamorphosis-of-european-equities","status":"publish","type":"post","link":"https:\/\/www.rbcwealthmanagement.com\/en-eu\/insights\/the-metamorphosis-of-european-equities","title":{"rendered":"The metamorphosis of European equities"},"content":{"rendered":"\n

By Fr\u00e9d\u00e9rique Carrier and Thomas McGarrity, CFA <\/strong><\/p>\n\n\n\n

\n We upgraded European equities to Market Weight from Underweight in March.\n Our bear case scenario was predicated on weakening economic and earnings\n growth momentum, but this no longer seems to be the case. The economy is\n showing signs of troughing.\n <\/p>\n

\n European equities present attractive opportunities, in our view, though\n misconceptions, anchored in the past, often prevent investors from seeking\n them out. We discuss the evolution of the European equity market since the\n global financial crisis and evaluate how to position portfolios advantageously.\n <\/p>\n \n

A changing face<\/h2>\n

\n European equity markets are often thought of as being dominated by \u201cold\n economy\u201d companies. This was indeed the case 15 years ago when low-growth\n sectors, such as Financials, Telecommunication Services (now called\n Communication Services), Utilities, Energy, and Materials, made up a\n significant portion of the MSCI Europe ex UK Index, which comprises\n large-cap and midcap companies across 14 European developed markets. With\n lacklustre earnings growth stemming from poor pricing power and a highly\n competitive environment, the stocks of many companies in these sectors\n have been languishing ever since.\n <\/p>\n

\n But the profile of the European equity market has seen a notable\n transformation. Those old economy sectors are now no more than a third of\n the index. Higher-growth-oriented sectors, such as Technology, Health\n Care, Industrials, and Consumer Discretionary, now represent some 57\n percent of the index, a sharp increase from 37 percent in 2011.\n <\/p>\n \n

\n Low-growth sectors have been scaled back, while higher-growth sectors have\n gained\n <\/h3>\n

\n Changes in the sector composition of the MSCI Europe ex UK Index between\n January 2011 and March 2024\n <\/h4>\n
\n
\n \"Changes\n \n The bar chart shows the change in sector composition of the MSCI\n Europe ex UK Index from January 1, 2011 to March 1, 2024. The\n low-growth sectors Communications Services, Energy, Materials, and\n Financials decreased the most, while higher-growth sectors Information\n Technology, Health Care, Industrials, and Consumer Discretionary\n increased. The changes are: Information Technology, +6.4%; Health\n Care, +5.4%; Industrials, +4.1%; Consumer Discretionary, +3.7%; Real\n Estate, +0.1%; Consumer Staples, -2.2%; Utilities, -2.3%; Financials,\n -2.6%; Materials, -3.0%; Energy -3.8%; Communication Services, -4.8%.\n <\/p>\n

\n Note: The former Telecommunication Services sector was expanded and\n renamed Communication Services in 2018.\n <\/p>\n

Source – Bloomberg, MSCI<\/p>\n <\/div>\n <\/div>\n

\n Notable changes are also afoot within industries. For instance, some of\n the formerly clunky and bloated conglomerates in heavy industries have\n slimmed down, spinning off underperforming operations to enhance capital\n efficiency, and are focusing on more modern, dynamic businesses and\n technologies. The Consumer Discretionary sector has also been transformed.\n It enjoys greater exposure to high-margin luxury goods, having benefited\n from demand arising from the growing middle class in emerging markets.\n <\/p>\n

\n The evolution of the index\u2019s composition has had several notable\n consequences. For one, approximately 55 percent of the revenue of index\n constituents is now generated outside Europe, lessening dependency on what\n has been an often lacklustre domestic macroeconomic backdrop, while\n providing exposure to economies with higher growth rates.\n <\/p>\n

\n Moreover, European companies\u2019 profitability, return on equity (ROE),\n earnings stability, and cash flow profiles have all improved. The ROE \u2013 a\n measure of profitability \u2013 of index companies reached 13 percent at the end\n of 2023, up from a meager 9.8 percent in 2011.\n <\/p>\n \n

\n Top 10 companies by weight in the MSCI Europe ex UK Index in 2011 and 2024\n <\/h3>\n
\n \n \n \n \n \n <\/colgroup>\n \n \n \n \n <\/colgroup>\n \n \n \n January 1, 2011\n <\/th>\n \n March 1, 2024\n <\/th>\n <\/tr>\n \n Company<\/th>\n Sector<\/th>\n Weight<\/th>\n Company<\/th>\n Sector<\/th>\n Weight<\/th>\n <\/tr>\n <\/thead>\n \n \n Nestl\u00e9<\/td>\n Consumer Staples<\/td>\n 4.4%<\/td>\n Novo Nordisk<\/td>\n Health Care<\/td>\n 4.8%<\/td>\n <\/tr>\n \n Novartis<\/td>\n Health Care<\/td>\n 2.7%<\/td>\n ASML<\/td>\n Information Technology<\/td>\n 4.7%<\/td>\n <\/tr>\n \n Total<\/td>\n Energy<\/td>\n 2.4%<\/td>\n Nestl\u00e9<\/td>\n Consumer Staples<\/td>\n 3.3%<\/td>\n <\/tr>\n \n Siemens<\/td>\n Industrials<\/td>\n 2.2%<\/td>\n LVMH<\/td>\n Consumer Discretionary<\/td>\n 3.0%<\/td>\n <\/tr>\n \n Roche<\/td>\n Health Care<\/td>\n 2.2%<\/td>\n Novartis<\/td>\n Health Care<\/td>\n 2.5%<\/td>\n <\/tr>\n \n Telef\u00f3nica<\/td>\n Telecommunication Services<\/td>\n 2.0%<\/td>\n SAP<\/td>\n Information Technology<\/td>\n 2.4%<\/td>\n <\/tr>\n \n Banco Santander<\/td>\n Financials<\/td>\n 1.9%<\/td>\n Roche<\/td>\n Health Care<\/td>\n 2.2%<\/td>\n <\/tr>\n \n BASF<\/td>\n Materials<\/td>\n 1.6%<\/td>\n Siemens<\/td>\n Industrials<\/td>\n 1.8%<\/td>\n <\/tr>\n \n Sanofi<\/td>\n Health Care<\/td>\n 1.4%<\/td>\n TotalEnergies<\/td>\n Energy<\/td>\n 1.7%<\/td>\n <\/tr>\n \n Daimler<\/td>\n Consumer Discretionary<\/td>\n 1.3%<\/td>\n Schneider Electric<\/td>\n Industrials<\/td>\n 1.5%<\/td>\n <\/tr>\n <\/tbody>\n <\/table>\n <\/div>\n

\n Note: Some company and sector names have changed since 2011. Total is now\n TotalEnergies; Daimler is now Mercedez-Benz. The former Telecommunication\n Services sector was expanded and renamed Communication Services in 2018.\n <\/p>\n

Source – MSCI, Bloomberg<\/p>\n \n

Finding its footing<\/h2>\n

\n For the remaining 45 percent of revenue generated within Europe, prospects\n have improved somewhat, in our view. The region narrowly sidestepped a\n recession in the second half of 2023 despite stomaching three shocks in a\n row: the pandemic, the sudden energy price surge following Russia\u2019s\n invasion of Ukraine, and a harsh monetary tightening cycle. In fact,\n economic activity seems to have troughed.\n <\/p>\n

\n Economic indicators such as the HCOB Eurozone Composite Purchasing\n Managers\u2019 Index have been improving since last October. The European\n Central Bank\u2019s (ECB) recent Bank Lending Survey points to lending\n conditions becoming much less restrictive. Real wage growth is improving\n amid falling inflation, and with markets widely expecting the ECB to cut\n rates in June, we anticipate the region\u2019s economy to continue to stabilise\n in coming months.\n <\/p>\n

\n We acknowledge that the European economy does not have growth potential as\n high as that of the U.S., being more highly regulated and with an ageing\n population. But consensus GDP growth forecasts are no longer being\n downgraded and are stable at 0.5 percent and 1.4 percent for 2024 and\n 2025, respectively.\n <\/p>\n

\n We see downside risk to these forecasts if labour markets were to\n deteriorate. Conversely, they could prove conservative if the Chinese\n economy were to improve, as Europe is a large exporter to that market.\n Moreover, if bank lending picks up as business confidence improves, this\n could feed into stronger investment growth, another source of upside risk\n to consensus GDP growth forecasts.\n <\/p>\n \n

A sheen of opportunity<\/h2>\n

\n Overall, as Europe\u2019s economy is stabilising, so too are corporate earnings\n forecasts. After declining for most of the past six months, consensus\n expectations now call for low-to-mid single-digit growth.\n <\/p>\n

\n Valuations are not stretched, in our assessment. The MSCI Europe ex UK\n Index is currently trading on a 12-month forward price-to-earnings (P\/E)\n ratio of 15x, in line with its 10-year average. We note, however, that\n over the past 12\u201318 months seven European quality growth leaders with\n global footprints including Novo Nordisk, the obesity and diabetes drug\n manufacturer, and ASML, the producer of extreme ultraviolet lithography\n systems for semiconductor manufacturing, have largely driven stock market\n performance and seen a notable expansion in valuations. Stripping out\n these companies leaves the rest of the stock market on a lower valuation.\n <\/p>\n

\n On a relative basis, European equities trade on a sharp discount to U.S.\n shares. Adjusting for sector weighting differences, the valuation discount\n is particularly stark. The Continent\u2019s P\/E ratio relative to that of the\n U.S. excluding the Tech sector is at its lowest level since the EU\n sovereign debt crisis in 2011.\n <\/p>\n

\n Importantly, a record number of European companies, particularly those\n with a strong balance sheet and a healthy level of cash, are increasingly\n buying back their own stock to boost earnings per share growth and improve\n their valuations. We also note that during recent earnings announcements\n more and more management teams have been mentioning plans to return\n capital to shareholders.\n <\/p>\n \n

Building balance<\/h2>\n

\n Given that the tentatively improving macroeconomic backdrop is set against\n a relatively low-growth environment, we continue to argue for a balanced\n approach to stock picking. We favour pairing high-quality secular growers,\n or global leaders listed in Europe, with selective exposure to more\n cyclically sensitive names, particularly in the Industrials sector.\n <\/p>\n

\n Long-term, we prefer the Technology sector (particularly mission critical\n software and semiconductor manufacturing equipment), Health Care, and\n Industrials names with exposure to the capital expenditure supercycles\n related to the themes of decarbonisation, deglobalisation (e.g.,\n reshoring), and higher defence spending. The luxury goods segment, within\n Consumer Discretionary, also benefits from powerful drivers, in our view.\n By contrast, we have a more cautious view of the Utilities and Consumer\n Staples sectors.\n <\/p>\n","protected":false},"excerpt":{"rendered":"

No longer wan and listless, we think European equities are emerging from their chrysalis with newfound potential. We look at how the investment story is transforming and why investors should take a fresh look at the asset class.<\/p>\n","protected":false},"author":142,"featured_media":13578,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"rbcwm_post_date":"2024-03-28T10:49:06","editor_notices":[],"rbc_url_alias":"","rbcwm_featured_desktop_image_position":"","rbcwm_featured_mobile_image_position":"","_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[80],"tags":[244],"rbcwm_content_owner":[506],"rbcwm_need":[],"rbcwm_segment":[96,97],"rbcwm_solution":[],"rbcwm_topic":[81],"rbcwm_channel":[],"rbcwm_format":[],"class_list":["post-13585","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-analysis","tag-european-equities","rbcwm_content_owner-pag","rbcwm_segment-business-owners-and-entrepreneurs","rbcwm_segment-individuals-and-families","rbcwm_topic-global-insights"],"acf":{"rbcwm_subtitle":"No longer wan and listless, we think European equities are emerging from their chrysalis with newfound potential. We look at how the investment story is transforming and why investors should take a fresh look at the asset class.","rbcwm_post_author":"","rbcwm_custom_breadcrumb_text":"","rbcwm_custom_breadcrumb_link_url":"","rbcwm_disclaimers":{"add_disclosures":["Yes"],"perspective_disclaimer":"","expandable":"","omit_from_pages":[],"disclaimer_footnote":""},"rbcwm_insight_cta_id":[8231],"rbcwm_pagination":{"next_link":"","next_link_text":"Next article","previous_link":"","previous_link_text":"Previous article"},"rbcwm_video_duration":"","article_time":"","rbcwm_enable_toc":false,"rbcwm_toc_selector":"h2"},"yoast_head":"\nThe metamorphosis of European equities<\/title>\n<meta name=\"description\" content=\"No longer wan and listless, we think European equities are emerging from their chrysalis with newfound potential. 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