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Investment Strategy

How European equities are defying the odds

Feb 10, 2023

The region is getting a boost from improved energy dynamics, China’s rapid reopening, slowing inflation and more—and it’s not all priced in.

Madison Faller, Global Investment Strategist

Matthew Landon, Global Investment Strategist

 

Our Top Market Takeaways for February 10, 2023

Market update

The push and pull


Investors continue to feel the push and pull of an economy in transition. In all, U.S. stocks stand to end the week lower, and bond yields have risen roughly back to where they started the year.

Here’s what we learned:

  • Say what you want to say, but without saying what you want to say. This week saw a flurry of Federal Reserve speakers, with the main event from Chair Powell on Tuesday. Powell largely stuck to his script—disinflation has been promising, but there is a long way to go, and more hikes aren’t off the table. But it’s what he didn’t say that mattered most: Despite last Friday’s blockbuster jobs report (which saw the U.S. economy add another 517,000 jobs in January), Powell didn’t suggest the Fed needed to hike above the 5.15% markets already expect. Read: Rates are already restrictive, and the economy should continue to feel it.
  • Returning to normal? U.S. jobless claims rose for the first time since December. While the unemployment rate is at a historically low 3.4%, a tick up in claims suggests that the overwhelming demand for workers has a chance of coming back in balance with labor supply. Read: The labor market is still super tight, but is starting to move in the Fed’s direction.
  • Not terrible, not terrific. Q4 earnings reports this week echoed that mixed sentiment. Disney beat estimates, but saw poor streaming numbers and announced a round of layoffs to cut costs. Ride-hailing company Lyft missed expectations and said it expects fewer riders, while its rival Uber saw shares bounce on strong demand for rides and food delivery. A relative bright spot came from Pepsi, which showed the power of its brand and pricing power. Read: Corporates are holding up, but also showing the slowdown.

But while U.S. markets wobbled, European stocks continued their climb. In dollar terms, the European market is on track for its seventh consecutive week in the green. Is the tide turning for Europe? Today’s Top Market Takeaways digs into five reasons why we think there might be cause for more optimism.

Spotlight

The case for Europe, in 5 reasons


Defying all odds, the outlook for Europe has continued to brighten. Here are five reasons we think the tide is turning.

1) Growth has been much better than expected—So much so that leading indicators are signalling expansion again.

While the region seemed to be teetering on the edge of recession heading into winter, improving energy dynamics have staved off the contraction most thought was inevitable. Thanks to a heroic effort to rebuild natural gas reserves and a milder than anticipated winter, natural gas prices have fallen by over 80% and are back at levels from before the war in Ukraine started. Europe looks to exit winter with better gas reserves (~50% of capacity) than it would even in a normal year (~30%). What’s more, Europe stands to reap tailwinds from China’s rapid reopening, given the economies’ trade linkages.

A MILDER WINTER HAS BOLSTERED GAS RESERVES

Sources: GIE Aggregated Gas Storage Inventory (AGSI), Bloomberg Finance L.P. Data as of February 6, 2023.
This chart shows natural gas storage for the EU, as well as its 10-year range and average, from April 1, 2022, until March 31, 2023. The first datapoint came in at 26.4%, with a 10-year average of 34.7% and a range of ~20% - ~55%. Then it rose to a peak of 95.5% by November 15, 2022, where the range rose to ~75% - ~96% and an average of 88%. From there until recently, natural gas storage fell to 69%, followed by the range and average, which are expected to decline to ~20% - ~50% and 34.8%, respectively, by March 31, 2023.

Finally, better still is that headline inflation looks like it’s slowing its roll—though we’d note the combination of still elevated prices and better growth are likely to keep the European Central Bank hiking for now.

2) All those good vibes translate into more resilient earnings. Banks largely reported stellar profits, lower gas prices have been a boon for industrials companies such as Infineon, energy companies such as BP are increasing capex for new projects, and luxury brands such as LVMH seem to be going from strength to strength.

Looking ahead, improved growth should boost sales, particularly as the Chinese consumer gets back in action. For instance, while Asia only accounted for ~11% of Stoxx Europe 600 revenues in 2010, it now represents more than 20%. Moreover, moderating prices should continue to ease some margin pressures.

EUROPE'S GEOGRAPHICAL REVENUE EXPOSURE

Source: FactSet. Data as of February 7, 2023.
This chart shows the revenue exposure by region for the Stoxx Europe 600: Europe: 47%, Middle East & Africa: 4%, Americas: 29%, Asia Pacific: 20% (up from 11% in 2010)
3) We don’t think it’s all priced in. Even with an over 20% rally from the lows, we think there could be more room to run. European stocks are trading at a 13x forward price-to-earnings ratio, below its 14.5x 10-year average. We also expect Europe’s discount to the United States to continue to narrow. It was at a historically wide 30% before this rally and has closed to ~26% today, and we expect it to finish the year closer to 20%.

EUROPE TRADES AT A NEAR 30% DISCOUNT TO THE U.S.

Sources: FactSet, J.P. Morgan WM. Data as of February 7, 2023.
This graph shows the 12-month forward P/E ratio of Stoxx Europe 600 versus S&P 500, from June 1, 2000, until February 7, 2023. The first datapoint came in at -2.8% and fell to -21.9% by September 10, 2001. Here, it rose before it declined to another trough of -22.8% by February 6, 2004. Then it rose to a relative peak of 6.7% before it fell to -25.6% by January 23, 2009. Here, it rose to -4.9% by September 11, 2009, before it declined back to -18.6% by September 16, 2011. Then it rose to an all-time high of 0.6% on April 10, 2015. From there until recently, it fell to an all-time low of -32.2% before it rose back to -27.1%. The chart also shows the +1 std. dev (-7.9%), -1 std. dev (-19.8%), Median (-13.4%), and the year-end 2023 outlook (-22%).

4) But it’s not just a short-term story—Europe is home to some of the growth trends of tomorrow.

This isn’t the same old Europe. The European market has seen its sector makeup shift from inherently lower growth industries such as telecoms and banks toward higher-quality companies such as luxury goods and semiconductors. Further, as the pandemic and war exposed supply-side vulnerabilities, we believe a capex cycle focused on developing the real economy is underway (think supply chain resiliency, energy and food security, infrastructure and defense)—in stark departure from the era of low interest rates that fueled mega cap tech in the last cycle. Such a shift could benefit Europe’s higher weighting to industrials, materials and energy versus its U.S. peers.

5) A weaker dollar adds an extra kicker for U.S. investors.

The U.S. dollar has weakened ~10% from its highs as U.S. inflation has cooled, other developed world central banks have caught up to the Fed’s rate hikes, and growth outside the United States has markedly improved. Meanwhile, the euro has rallied, and the dynamics above should also give it further support. That means USD-based investors could see even more enhanced returns when investing in European assets. For example, since the start of October, the Stoxx Europe 600 has generated a compelling ~20% return in local currency terms, but an even higher ~30% in dollars!

Investment implications

Think outside the box


Europe accounts for only ~3% of U.S. investors’ total equity allocation, despite accounting for ~20% of the global equity universe; 2022 was also one of the worst years for flows out of European equities in the last decade. Many investors are underweight Europe, and looking ahead, while there remain risks around the war and the evolving business cycle, we believe the latest green shoots warrant a closer look.

In the multi-asset portfolios we manage, we’ve been increasing exposure. Some might also consider adding to broad markets with downside protection through structured notes. We likewise see opportunity in Europe’s national leaders across luxury, semiconductors and energy—many of which are aligned with policymakers’ priorities and may also provide stability in the face of any further volatility.

That said, at the same time, stresses remain, and a window appears to be opening for investors with expertise in special situations to acquire assets at a discount, and to restructure troubled credit and real estate. Such strategies can generate yield and offer diversification if things go the other way.

Your J.P. Morgan team is here to discuss these insights and their impact on your portfolio.

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All market and economic data as of February 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

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All market and economic data as of February 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

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STOXX Europe 600 Index (SXXP Index): An index tracking 600 publicly traded companies based in one of 18 EU countries. The index includes small cap, medium cap, and large cap companies. The countries represented in the index are Austria, Belgium, Denmark, Finland, France, Germany, Greece, Holland, Iceland, Ireland, Italy, Luxembourg, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom.

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