Picking the European winners of the future

He says investors are treating European equities as though the companies are the same as the economy, and the market perception is that the eurozone economy is structurally unsound.

Hugh Cuthbert, who runs the European equity fund at SVM, says stocks listed on markets within the eurozone area always trade at an “inherent discount” due to a widely held view that the euro currency is unstable and will collapse. 

The existence of the euro means economies that are at vastly different stages of their cycle will have the same interest rate, so some economies could have rates higher than their economies would justify, while others would have rates lower than ideal for their economies.

This could create a conflict whereby some countries want rates to rise, and others want rates to fall.

In the event of a subsequent recession, the risk is that membership of the euro becomes a source of discontent for populations, increasing political risk in a way that could pose a risk to asset prices across the economic bloc.  

Key Points

• There are questions over whether European equities are well placed for the changing world, post-Covid
• Some investors are dubious about the viability of the eurozone
• Luxury goods is an area of strength for Europe

The second reason the image of the eurozone may be impeding the progress of its equity markets is a growing belief among investors that European equity markets are stuffed full of the sorts of companies that will fall from favour as the world embraces new ways of working, communicating and socialising, and companies that are likely to be hard hit by any pandemic-induced prolonged recession.

Examples across both of those trends include banks, big oil companies and traditional automakers, all sectors that are significant parts of eurozone stock markets.

Energy theme

In contrast, there is a lack of global leading new technology companies, the sorts of businesses that are likely to be winners from the changes sweeping the world. 

One of the significant themes of the future is energy transition, as the world moves away from fossil fuels, and this is an area where Europe really does have world leaders James Sym, River and Mercantile

James Sym, European equity fund manager at River and Mercantile, says that while the economic bloc lacks technology champions, it is a world leader in some of the environmental sectors. 

He says: “One of the significant themes of the future is energy transition, as the world moves away from fossil fuels, and this is an area where Europe really does have world leaders.

“Orsted is an example of a leading company in this area that is European in origin. And while the theme of energy transition is just as significant as many of the themes large technology companies are part of, they have valuations that are much cheaper than those of the big tech names.”

Mr Cuthbert is also keen on this theme, and says the value comes from many of the renewable energy assets in Europe being owned by traditional energy companies, which the market ignores as being part of the old economy. He says this makes the shares more attractively valued.  

He believes a mistake that many investors in European equities make is that in an effort to diversify away from expensive US shares, they buy cheap European ones, with the result that they end up buying companies that are going to lose out from structural changes and so are “cheap for a reason”.

Ben Richie, head of European equities at Aberdeen Standard Investments, says another area where European names are predominant is in business-to-business technology, where the structural changes are just as profound.   

Michael Crawford, chief investment officer at Chawton Global Investors, takes up this theme.

He says a number of European companies are world leaders in manufacturing the components used to make semi-conducters, and semi-conducters power much of the technology that is changing wider society.

Giles Rothbarth, co-manager of the BlackRock European Dynamic equity fund, says: “Covid-19 has accelerated many market trends, one of which has been the funding of Europe’s green agenda to help build its competitive edge.

“The recently agreed €750bn (£676.7bn) EU recovery fund will be the cornerstone of the European growth plan, with an estimated 80 per cent of spending focused on the digitisation of the European economy and also the pursuit of an ambitious net carbon zero goal by 2050.

“We see this agenda creating tailwinds for Europe’s leaders in the semiconductor industry, driving transition in 5G and cloud computing as well as electric vehicles, and for those companies that will provide ever-more renewable energy in the future.”

Growth in luxury goods

The EU recovery fund also marks a change in the political climate in the eurozone, as it means the economic bloc has agreed to borrow jointly.

James Dowey, global equity fund manager at Liontrust, says while many market participants have been aware of the political climate for years, the recovery fund may mean the economic bloc’s political outlook is now superior to that of some other markets.  

Niall Gallagher, European equity fund manager at GAM, agrees that an investor buying a European equity tracker fund as a way to access a cheap market would own lots of unappealing companies. He believes the growth trend in which European companies are leaders is that of luxury consumer goods.

He says that as emerging market consumers get wealthier, they have become a new market for luxury goods businesses, and with a vastly expanded market, those companies, such as LVMH, have become better investments. 

Mr Gallagher says the European luxury goods makers, which include alcohol manufacturers of gin and whiskey, have brand power that rivals would require years to develop. 

He says: “Younger people in emerging markets tend to like premium spirits, and European listed companies are the leaders there.”

John Surplice, co-head of European equities at Invesco, agrees that luxury goods is an area of the market where companies in the economic bloc are strong, but adds that he feels the positive news from such trends is already reflected in valuations. As a result, he has little invested in that part of the market.   

Instead he says that many of the companies in Europe have suffered in share price terms in recent years as a result of inflation being very low, but that the waves of extra spending by governments, coupled with very low interest rates, could mean that a feature of the future economic landscape is that inflation is much higher in the years ahead than it has been for the past decade.  

He says in such a scenario, eurozone shares in areas such as utilities would perform well as they have revenues linked to inflation, and, with inflation being very low, the shares of those sorts of companies have suffered in recent years. 

And then there is Covid-19 to consider – a response to which might help boost European pharmaceuticals. Ben Peters, who runs the Evenlode Global Income fund, says many European pharmaceuticals are global leaders and demand is unlikely to fall in the years ahead. 

So while Europe might have an image problem, a little closer look will show some rather attractive stocks.

David Thorpe is special projects editor at Financial Adviser and FTAdviser