To investors, continental Europe can sometimes present a face only a mother could love. In English-speaking investing communities, an image exists of the EU — now sans the UK, one of Europe’s most market-savvy countries — as a crusty, statist, and conflict-torn bloc, over which leading investors regularly wring their hands in disappointment.
In this narrative, the confusion over the union’s pandemic vaccine-buying programme counts as only the latest in a whole history of blots on the Brussels copybook. In an article entitled, “Europe, please wake up”, even the avowedly pro-European billionaire financier George Soros once warned that the EU could “go the way of the Soviet Union”. Who in their right mind would place their money in a region so obviously marked by decline?
Bond investors still cannot forget the threat that hung over Greek and other sovereign bonds in the 2010-12 eurozone debt crisis. The stock prices of Europe’s banks have struggled to tread water since. More broadly, not only have European shares failed to recover from the March pandemic market shock anywhere near as well as the US’s, they have consistently lagged behind the US since the 2008 global financial crisis,
In the past decade, the US S&P 500 index has more than tripled while the Stoxx Europe 600 index of top European shares is up only about 40 per cent. US shares now trade on a price/earnings multiple of about 23, compared with 16 for European equities.
Such generalisations are of course too sweeping. The performance gap between US and EU equities, for example, is largely down to the different composition of their markets, with soaring tech stocks making up a much bigger share of US equity indices and accounting for much of the outperformance.
Where’s the next Atlas Copco?
International investors who have passed on Europe in recent years have missed some golden opportunities in tech.
On a sector-by-sector basis, things look more equal: indeed European stocks may be priced slightly higher than corresponding US ones. Europe remains a world leader in many areas, ranging from luxury goods and top-class cars to specialised chemicals and high-end engineering. Louis Vuitton, Daimler, and Gucci are still iconic brands.
But the old continent certainly has a lot of bearish factors about it, which are not likely to change.
Europe is old by global standards, and still ageing. Addressing the European Parliament in 2014, Pope Francis himself likened Europe to a “grandmother, no longer fertile and vibrant”. Without an unexpected change of heart towards welcoming many more immigrants, demography will limit Europe’s potential growth.
That shrinks the space for high-return deployment of capital compared to more dynamic economies, such as the US and East Asia. If productivity growth remains sluggish, it will make things worse. This millennium, output per worker has grown by just 17 per cent in the eurozone, against 32 per cent in the US, according to OECD figures.
Then there is Europe’s cumbersome political decision-making apparatus. The EU is arguably too democratic, with too many veto holders who can obstruct action. That may be good for legitimacy, but makes it hard to make big decisions fast. Even in the trench war of US politics, Washington has agreed huge fiscal packages, thanks to which the US economy has weathered the pandemic better and can look forward to a stronger recovery than the EU.
So it’s difficult to view Europe as an imminent breakout growth market. But that’s not the end of the story. There is a bullish case to be made. Investors who take the trouble to look will see that transformations are afoot in the bloc that will have a strong impact on fundamental drivers of the economy and stock market valuations.
Those changes are opening opportunities for the investors able to deduce where the financial rewards will be greatest. They also underline how, contrary to widespread perception, the EU is catching up with the times — and may even be getting ahead.
The first big change is eurozone’s macroeconomic policy rethink. Incentives for fiscal and monetary conservatism, keeping tight the purse strings, were hard-coded into the Maastricht treaty, that created the common currency.
Policymakers held to their principles. Even after the global financial crisis, the European Central Bank increased interest rates in 2011, just as every euro government tightened fiscal policy, resulting in a double-dip recession.
But things have changed since. The European Central Bank’s default mode has become less hawkish. Its deposit rate has been negative since 2014. The pandemic blew away any remaining caution as the central bank doubled down on bond purchases with a new €1.85tn programme.
On the fiscal side, the EU’s tough budget rules have been suspended because of Covid-19. Already before the pandemic, a consensus that the regulations were not fit for purpose was fuelling a debate about wholesale revision.
In relaxing macroeconomic policy, the EU is following the US, where the Federal Reserve shifted its strategy in a dovish direction last summer. But the union is catching up fast, and the economic effect is likely to be more dramatic, as growth is so much weaker.
The second big change happened in mid-2020, when EU leaders agreed with remarkable speed on a €750bn post-pandemic recovery fund. This crossed not one but two Rubicons: that of outright monetary transfers from richer to poorer governments and that of common eurozone borrowing. This could prove a game-changer for how to think about investment in continental Europe, not because of the recovery spending itself (which, while unprecedented, is dwarfed by national budgets), but because of its political and financial implications.
Politically, it is a big step in the direction of further integration and shows again that EU leaders are willing to take previously unthinkable steps if the bloc’s cohesion is threatened. That should, in particular, reassure those investors worried about the euro’s long-term survival.
So should the financial implications. A significant amount of the new “eurobonds” — securities guaranteed by the EU countries’ common budget — will remain outstanding for the next 40 years. This common “safe asset” will help stabilise the eurozone, and doubtless soon be the mainstay of banks’ asset management, helping them diversify out of national sovereign bonds. It may also aid in energising the EU’s agenda to integrate its fragmented financial markets.
Even more economic benefits will come if this emergency funding spurs regular common borrowing, as many pro-EU observers hope. For investors, the prospect of a stabler and more integrated financial system points to looking anew at Europe’s low-priced bank shares — and spotting the likely winners.
The third, and arguably most important, change is how fast the green agenda has become a guiding principle for EU and national decision-making. This started before the pandemic, following the youth protests against inaction over climate change, personified by Swedish teenager Greta Thunberg. Green parties did well in the 2019 European parliament election, and at national level several governments are now made up of coalitions including the Greens or relying on them for parliamentary support.
The European commission president, Ursula von der Leyen, grasped the moment and made the “European Green Deal” the flagship policy of her tenure. Its real importance is not in the amount of “green” spending from the EU budget or its post-Covid “Recovery and Resilience Facility” — where some climate campaigners complain of “greenwashing”. But because the Green Deal framework has aligned with national governments’ plans, it puts climate considerations squarely into all EU decisions.
It will have the most impact on regulation. In just over a year, the EU has set new, ambitious targets for carbon emission cuts by 2030 and 2050. It is about to expand the emissions trading system and probably introduce a “carbon border adjustment” — import tariffs based on carbon content. It is preparing a “green taxonomy” that will classify types of assets and investments according to how they fit with decarbonisation. It is looking at the prospects for hydrogen-powered transport. It is subsidising battery development, promoting recycling and requiring climate-related financial disclosures from large companies.
This will all show up in changes in relative prices inside European markets, and therefore changes in the relative return on investments in different sectors and companies depending on how well they are situated in the race to decarbonise.
The biggest impact may come from the European Central Bank which, under the tenure of former IMF chief Christine Lagarde has committed itself to taking climate change seriously.
In a speech last year, Isabel Schnabel, a member of the bank’s executive board, said “collective action . . . including the ECB, is required to accelerate the transition towards a carbon-neutral economy and correct prevailing market failures”. She questioned central banks’ traditional principle of “market neutrality” — trying to treat all economic sectors equally — suggesting that monetary policy could aim to shift capital away from “brown” and towards “green” investments.
There is no doubt about the EU institutions’ commitment to promoting capital allocation towards decarbonisation. About 20 per cent of total EU energy consumption comes from renewable sources today — the bloc wants to reach 32 per cent by 2030.
Investors would be wise to form a view about how big the shift will be. As an analysis from Pictet, the Swiss private bank, puts it, Europe’s “climate target is set to disrupt and transform a number of industries, each representing rich and diverse investment opportunities which are under-appreciated by the wider market”.
Corporate managers across Europe see where the wind is blowing. So do institutional investors. Yngve Slyngstad, the former head of Norway’s $1.3tn sovereign wealth fund, says all big investors “are there now” in taking environmental concerns seriously, and insists investments that are sustainable in a climate sense will also be more sustainable financially.
All this puts European businesses in a good position to reap the rewards of being better prepared for decarbonisation than other rivals. The prospect of steeply rising carbon prices, for example, or of penalties on holding assets falling foul of climate rules, means businesses that provide carbon-saving solutions could gain greater profits in Europe than in other markets. Thanks to policy incentives, Europe is now, for example, the world’s biggest market for electric vehicles.
As other regions follow the EU in refashioning climate regulations, EU-based businesses that gained scale thanks to the green push at home could aim to expand further into global markets — to the benefit of shareholders. Vestas Wind Systems, the large Danish turbine maker is just one example of a company that has already seen its stock market valuation soar. Another, smaller, investor darling is Tomra, the Norwegian recycling machine maker.
The old continent remains unquestionably old and its overall GDP growth prospects are undoubtedly limited. But within its ageing population and sluggish economy, it still retains the power to create innovative business forces — and new investment opportunities.
Where’s the next Atlas Copco?
International investors who have passed on Europe in recent years have missed some golden opportunities in tech, writes Stefan Wagstyl.
While the region lacks consumer-facing giants, such as Facebook in the US, and China’s Alibaba, it scores in the nuts and bolts of tech, both in software and hardware.
And Europe-focused fund managers think that even after recent price rises, the sector still has a lot to offer investors, including retail savers. “Europe is a good opportunity now,” says Gavin Launder, manager of the European fund at L&G, the investment group. “Governments are now quite keen to promote tech-savvy companies. Europe’s industrial and B2B tech is very strong.”
Launder’s fund last year rose 46.7 per cent and topped the list of open-ended Europe-oriented funds ranked by Morningstar, the data group. Over the decade to 2020, it gained a healthy 11.1 per cent annually.
Top picks in Launder’s £175m fund include ASML, the Dutch company dominating world supplies of photolithography machines for chipmaking, currently benefiting from global production shortages. Other stars include Delivery Hero, the Berlin-based online food supplier, and Shop Apotheke, a Dutch online pharmacy.
While tech companies’ growth has been accelerated by the pandemic-induced switch to ecommerce, Launder sees further expansion in the coming years.
So does Stephen Paice. He manages fund house Baillie Gifford’s European Growth Trust, which, Morningstar says, rose 64.8 per cent last year, coming top among investment trusts, and by an annualised 12.9 per cent over the past 10 years. “For the first time in a long time in Europe we have an entrepreneurial mindset. We are starting to build up tech businesses.”
Zalando, the online fashion retailer, is among his top stocks. So is Adyen, a Dutch online global payments manager, and Adevinta, a Norway-based developer of online listings businesses for property and the like.
Paice foresees a real reshaping of Europe’s stock markets, with companies that have traditionally dominated by market capitalisation, such as banks and industrial combines, giving ground to tech. He says: “I think this is one of the biggest changes coming among leading European companies.”
Green industries are also expected by fund managers to power growth. Favoured companies include Vestas Wind Systems, the Danish turbine maker which saw its shares soar 150 per cent in 2020, Alfen, a Dutch company investing in electric vehicle charging points, batteries, and micro electrical grids, and Neste, the Finnish oil group developing synthetic fuels.
Stefan Gries co-manager of the Greater Europe Investment Trust at BlackRock, the US investment giant, says: “Europe has long been seen as the global leader when it comes to ESG and sustainability.” Gries’s trust gained 32.2 per cent last year, according to Morningstar, the second best performance after the Baillie Gifford vehicle.
Meanwhile, fund managers still appreciate traditional strengths in European business, including cohesive corporate cultures, long-term horizons, and, often, the stabilising presence of founding families. Paice’s fund has held Atlas Copco, a Swedish pumpmaker for 35 years, making a 40-fold return in the last 20. “We want to find the next Atlas Copco,” he says.
Of course, not everything works out. Shareholders in Airbus were battered last year by the pandemic. Owners of European bank stocks have suffered for much longer, as lenders failed to fully recover after the 2008 global financial crisis. And the collapse last summer of German payments group Wirecard, amid claims of fraud, shows European tech also faces challenges. Overall, the MSCI Europe index, excluding the UK, rose only 7.5 per cent last year. That was better than Brexit Britain’s depressed market but far short of the US’s S&P, which rose 16 per cent.
But the point, say Europe bulls, is not that Europe is perfect. It’s simply that it’s a lot better than many investors think.
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