Europe’s strong performance may be a surprise, given the continent's vaccination issues.
Since the start of the year, European stocks have fared relatively well. The MSCI Europe Index has produced a return of 7.8%, in sterling terms. In comparison, the MSCI All-Country World Index has returned 5.3% and the US’ S&P 500 has returned 7.7% (to 18 May).
Key European indices have also recently reached, or neared, all-time highs. For example, the pan-European STOXX 600 index reached a new all-time high in April.
More recently, the Dax Performance index, Germany’s headline index, reached a new high on 18 May.
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Europe’s strong performance may be a surprise. After all, the continent has broadly seen one of the slowest and most troublesome vaccine roll-outs among developed economies. While both the US and UK, among others, took the lead in vaccinations and re-openings, Europe spent the first quarter of the year struggling with new outbreaks. Meanwhile, when compared to the US, fiscal support has been relatively weak.
However, what the strong performance of European equities shows is largely the international and cyclical nature of its indices. While a company may be listed in a certain country for historic reasons, the characteristics of the stock is often more important.
European equities have been well-positioned to benefit from the global economic recovery. Many of Europe’s leading companies sell their output abroad, meaning a global economic recovery, from the US to East Asia, has propelled European stocks forwards.
Crucially, however, since the announcement of the vaccines in November, markets have been gripped by the ‘re-opening’ and ‘reflation’ trade, which has entailed the strong performance of value and cyclical stocks. That has been good news for Europe, whatever the domestic situation.
As Francesco Conte, manager of JPMorgan European Smaller Companies (LSE: JESC), argues: “Following unprecedented fiscal and monetary policy, we should not be surprised to see Europe benefit once again as the current anaemic economic recovery morphs into a synchronised global recovery.”
Figures from WisdomTree illustrate the cyclical nature of European indices. For example, 44% of the MSCI Europe Index is deemed cyclical. Removing the UK (MSCI Europe ex UK) reduces this to 42%. However, that is still well above both the US and world. Just 25% of the S&P 500 is deemed cyclically sensitive and 32% for the MSCI World Index.
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The importance of cyclical stocks in the recent rally is also shown by the better performance of UK stocks compared to the European index, with the FTSE All Share returning 10.38% year to date. As WisdomTree’s figures show, cyclically sensitive stocks make up 53% of the MSCI UK index.
However, things may also be looking up for the European economy domestically, following a poor first quarter. As Jon Turek, from JST Advisors, points out in his CheapConvexity newsletter: “European purchasing manager index (PMI) [data] on both the services and manufacturing show that the economy inflected in the second quarter.”
April’s European PMI data showed the economy was experiencing its fastest expansion since July 2020 and the second best in over two and a half years.
Turek quotes the PMI data release directly: “April’s survey indicated that confidence about the outlook was at its highest since composite data were first available in mid-2012.
“Increasing confidence about the future led to a strengthening of business expectations to their highest level since May 2017.”
It is also important to note that service sector output in Europe returned to growth in April, albeit by only a small amount for now. While Europe was off to a slow start on vaccines, the continent now appears to be on track to meet the European Union Commission’s target of 70% of the population vaccinated by July.
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An added potential bonus for Europeans stocks, however, may come from a potential big political change in Germany, Europe’s most important economy.
Germany, under Angela Merkel’s coalition committed to keeping budget deficits small, which many argue has held back European growth prospects. However, Turek points out that the Green Party is seeing a surge in support in the polls. If this translates into an electoral victory later in the year, Germany could see a big lurch towards bigger fiscal spending, as we have currently seen in the US under Joe Biden. That, in theory, would be highly supportive of European stocks – particularly cyclical ones.
Turek says: “The question now for markets is, can the elections turn into a [Biden] “Blue Wave” type narrative where the market has to assume a new era of higher fiscal spending?
“If the Greens have a big election, that could alter the landscape of pan-European fiscal spending.”
Fund managers are also bullish about European stocks. As the latest European Fund Manager Survey from Bank of America Merrill Lynch reported: “Investor confidence in the European value rally has increased, with 43% of respondents saying the value rotation will continue throughout the year, up from 26% last month.”
A detailed explanation of Europe’s many stock market indices and the various ETFs that track them can be found here.
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