By Tim Sharp, Hottinger & Co.
Another strong US reporting season has left European companies in the shade and the focus on the passage of President Biden’s $1.9trn stimulus plan through Congress has left any thoughts of the EU’s own stimulus plans behind. The US stock market has been the investment leader throughout the pandemic at a time when low interest rates, quantitative easing and ownership of the world’s reserve currency has favoured long duration, growth stocks operating in the most forward-looking sectors. However, the differential between US and European earnings estimates may actually be an indication of investor sentiment that is over confident of US earnings and overly pessimistic of European earnings prospects[i].
The re-opening of developed economies will see the more cyclical sectors recover, and the signs are that there is significant pent-up demand from consumers to return to the service industries reminiscent of the “Roaring 20’s”. Tragically, the burden of a recession caused by lockdown has fallen on the bottom 20% of society and disproportionately on the young, however, the rest of society, unusually for a recession, has managed to improve their liquidity to some degree. If the anecdotal evidence of the pick up in activity within the travel industry is anything to go by, we expect the sizeable accumulation of household savings during the pandemic will see growth bounce back forcefully. Export dependent economies, like many in Europe, are likely to be major beneficiaries of spending and European luxury goods and capital goods’ companies in particular are expected to see the return of strong demand[ii].
The global reflation trade has seen government yield curves steepen which pressurises long duration growth stocks in our opinion because the interest rate used to discount future earnings increases. Further, flat yield curves and negative rates are a poor environment for financials and depress banks’ net interest margins. We expect steepening yield curves to provide an environment in which value outperforms growth or more precisely, financials outperform technology. Year-to-date the S&P500 Technology Sector (XLK) is 0.33% weaker while the Financial Sector (XLF) has gained 17.10% showing that this rotation has been significant so far this year[iii].
Source: Bloomberg as at 11 March 2021
The next question is whether European banks can outperform their US counterparts.
Absolute Strategy Research believe that Eurozone equities will find it difficult to outperform US equities unless European banks re-ratei. A period of consolidation in the European banking sector across borders is now actively encouraged by European regulators that now see the fragmented banking sector as a disadvantage and are looking to complete the EU single market in financial services now that the Brexit negotiations are overii. European banks still play a very prominent role in corporate funding and supporting the growth in the real economy. A European “Big Bang” could prompt financial innovation which would also support the green deal going forward.
The inauguration of Joe Biden as US President saw the US swiftly return to the Paris climate accord which bodes well for the increased focus on environmental standards in future world trade. Following European agreement of the EUR750bn EU recovery fund that was triggered on January 1, 2021, the EU plans to put EUR1trn to work in sustainable investment over the next 10 years as part of the Green Deal making Europe one of the global leaders in sustainable energy[iv]. For example, JPMAM’s Karen Ward points out that three quarters of global wind assets have company headquarters in Europeii.
The EU recovery fund has introduced a level of fiscal union to complement the single currency monetary union for the first time, the absence of which could be blamed for the severity and slow recovery after the Global Financial Crisis. The risk premium that has been attached to the inflexibility of the European equity model sees the MSCI Europe Index ex UK trade at 18 times forward earnings when the S&P500 trades at 23 times forward earningsii. The structural changes underway within Europe will support European Banks, the re-opening of the global economy will support cyclical goods and services within established export channels to the growth areas within China and Asia, and the embracing of the environmental challenge will push European innovation and growth. European equities remain under-owned and cheap relative to more growth orientated sectors and regions in an environment that increasingly plays to its strengths.
[i] Absolute Strategy Research – Eurozone Equites: Focus on the Banks, February 11, 2021
[ii] Financial Times – The Consensus is Wrong on European Stocks by Karen Ward, JPMAM, February 15, 2021
[iii] Statistics referenced from Bloomberg Professional Terminal data.
[iv] Portfolio Adviser – Why European Equities could rise as the US Stock Market lustre fades by Cherry Reynard, October 14, 2020.
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