Europe equities are too cheap to ignore

The writer is chief market strategist for Europe, Middle East and Africa at JPMorgan Asset Management

While the US economy showed extraordinary resilience last year, Europe has had a tougher time of it with growth stagnant, at best. But, I would argue, expectations for Europe are now far too low. This underperformance stems in large part from the ripple effects of Russia’s invasion of Ukraine and the ensuing energy crisis. Losing its main supplier of natural gas, Europe faced a colossal shock. Spiralling bills hit households, permeating through the price of other goods and services, as businesses passed on higher costs.

While energy prices rose globally in 2022, the cost of living crisis has been much more painful and prolonged in Europe. Consumer confidence followed the drop in household spending power and so, despite both US and European households having sizeable pandemic-related savings, Europeans chose to hoard those savings. By contrast, US consumers put those savings to work, making up for the experiences and holidays lost during the pandemic.

Fiscal policy was another source of divergence between the two regions. Across the Atlantic, the American Rescue Plan, the Chips Act and the Inflation Reduction Act have played a significant role in driving growth. Indeed, it is important to not overlook the fact that the recent growth resilience we have seen in the US is at least in part down to government spending, with the budget deficit running at 6 per cent of gross domestic product.

Europe should also have had a meaningful stimulus in the form of the €750bn recovery fund. But there have been delays in deploying the money and only a third of grants have been spent.

The other policy lever — monetary policy — likely also did more damage than in the US. Europe’s consumers and businesses are more dependent on short-term commercial bank financing than in the US, which draws more heavily on long-term interest rates and capital markets for financing. Less than 30 per cent of business financing in the eurozone comes from capital markets compared with 70 per cent in the US.

Compounding these domestic European problems, global manufacturing has been stuck in the doldrums. Quite simply, households accumulated too much “stuff” in the pandemic and turned their attention to spending on services as soon as reopening was complete. Europe’s manufacturing-heavy economies, like Germany, therefore suffered particularly acutely.

As we look ahead, many of these former headwinds to European growth are quickly turning to tailwinds. Europe has done an extraordinary job of pivoting its energy supply from Russian pipeline gas to LNG. With the good fortune of a relatively mild winter, gas prices have fallen quickly, taking headline inflation with it. Over the summer months, European households may even experience a positive cost of living shock.

With the jobs market still firm, households are starting to see a real wage boost. The rebound in consumer spending could be more pronounced if households grow sufficiently confident to spend their pandemic savings. The ECB is likely to encourage this recovery, with rate cuts and monetary and fiscal policy working in the same direction, as the recovery fund is increasingly spent in the eurozone. By contrast, the US election might force a discussion about reining in spending to tackle spiralling debt.

FT Survey on UK investment

Have you found a great British bargain? Tell us the UK stocks that you think are worthy of including in your Isa - and why via a short survey

Perhaps the one piece of the puzzle missing is a strong bounce back in Chinese demand, given Europe’s export exposure. But Europe’s domestic recovery should, in my view, be enough to drive a substantial uptick in growth.

Europe’s economic data is already starting to surprise on the upside, but markets are proving slow to adjust. The equity market is not priced for economic convergence, for example. Expectations are for European earnings to grow at 4 per cent this year and the forward price-to-earnings ratio on MSCI Europe is just 14.7 times. This compares with expectations of 10 per cent for US earnings against a forward PE of 20.8 times.

One also has to consider the role of technology and the current AI euphoria. The stellar performance of a handful of tech names have helped the S&P outperform European benchmarks, not just in the past year but the past decade. I would argue that concerns about the concentration of the US market and uncertainty about whether AI will live up to the hype are key reasons for investors to consider shifting some of their allocation from the US to European stocks.

Investors should take advantage of valuations before the European recovery gathers steam. The tide may be about to turn.