Many have called for the outperformance of European equities as they once did for Japanese equities over the past few years. The reality has been mixed. The question now is whether it is time to increase exposure to Europe and the Nordics in a world where many equity markets are very expensive. The answer is most likely yes.
European earnings should start to strengthen with demand
Europe, like the US, is going through an economic recovery but inflation is lower than in the US and is showing signs of easing on the back of improved supply chains. There is also far less evidence of a wage inflation spiral. Indeed, the Eurozone economy is running too hot but far less than the United States. The outcome is that earnings should probably surprise positively this year in part on the back of stronger demand and controlled costs. One reason this is likely to happen is that consumers are steadily becoming more confident not only about growth, but about the long-term prospect for the Eurozone as we move away from a long period of crisis (from the Peripheral crisis to the Pandemic). Another factor is that innovation is starting to pick up all across Europe from the Nordics to the south. The last element is that while monetary policy could tighten, it should remain ample and this is in stark contrast to the United States. The net outcome of this is that the euro should stay somewhat weak relative to the dollar and is expected to stay south of 1.20.
The value tilt in an expensive world
European equity has a tilt towards Value and Cyclical which for a long-time meant that US equities, with their Growth and Quality factors, were more in demand. Now, Value/Cyclicals should benefit ever more from rising demand and fear that the Growth/Quality investment styles are very expensive (which is very sensitive to higher interest rate yields). A probably better earnings profile linked to better demand should also help. What should support this is the rapid digitalization of Europe supported by the European Union. More importantly, many reforms were delayed by the crisis and are likely now to come to the fore.
The question is why buy now? Europe is starting to reinvent itself through digitalization and Green policies to become more agile. Long-term low interest rates support the development of new technologies which are often long-term bet on the future. AI policies have been deployed by the EU, for example, and the race to catch-up with the US and Singapore should rapidly heat up. We are simply at the beginning of a new style European economy that should over time be as productive and innovative as the US economy but far more egalitarian, influenced by Nordic values. Companies which for decades preferred to develop in the US or Asia are going to start developing operations at home. That change in belief in long-term European growth may oscillate over time, but as stock prices rise it should comfort CEOs into investing more at home leading to a self-fulfilling cycle.
What does it mean?
Within Europe, we see that Nordic countries equities have long outperformed with their emphasis to global growth and the quality of the companies involved. We expect this to continue.
