In November of last year, what many considered to be another catastrophic development for Europe's struggling assets turned unexpectedly optimistic as investors began to place their bets on a resurgenceThis apparent shift from pessimism to a more hopeful outlook regarding European equities raised eyebrows, particularly given the historical context of the European market’s performance, which had been overshadowed by its American counterpart.
The backdrop for this change in sentiment is crucial to understandSince the 2008 global financial crisis, European stock markets have consistently lagged behind the robust gains of U.S. marketsThe rise of powerful tech giants in America, buoyed by the recent AI boom, has contrasted sharply with the sluggish growth in European industriesTraditional European strongholds, particularly the once-mighty German automotive sector, have struggled to keep pace with emerging competitors like Tesla and BYDThese developments, combined with the new U.S. administration’s threats of tariffs on European goods, crafted a bleak narrative for European investments.
However, astonishingly, throughout the past several weeks, the European market has defied expectationsThe EURO STOXX 50 index surged by 12% since November, considerably outperforming the S&P 500, which managed only a 3.5% increase in the same periodData from EPFR illustrates a dramatic shift, as European-focused equity funds welcomed their largest net inflows since early 2022 during the third week of FebruaryThis newfound interest has positioned European stocks as a significant focal point in global markets.
So, the question arises: How did European stocks manage to outshine their U.S. counterparts? One possible explanation lies in the evident valuation risks associated with America's “big seven” tech firmsAs concerns over inflated valuations grew, European markets, characterized by relatively lower valuation levels, emerged as an attractive diversification option for investors
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Current predictions for earnings over the next year suggest that European equities boast a yield premium that surpasses U.S. stocks by nearly double, as evidenced by the current earnings yield on European equities being 6 percentage points higher than the yield on inflation-protected government bonds.
Moreover, although recent surveys indicated a lack of enthusiasm in the manufacturing sector, there are promising indicators that Germany's industrial downturn may soon turn a cornerAnalysts on Wall Street are forecasting positive growth figures for German auto manufacturers like Volkswagen and BMW in the latter half of this year, suggesting a potential turnaroundThe forecast from LSEG IBES also reveals an intriguing trend, predicting a significant acceleration in European corporate profit growth to 7.9% by 2025, a stark contrast to the mere 1% growth anticipated for 2024 and continuing negative trends observed in 2023.
As Marc Halperin, Co-Head of European Equities at Edmond de Rothschild pointed out, many investors remain underexposed to European stocksAs various economic indicators begin to reflect improvement, coupled with the anticipated monetary policy adjustments from both the European Central Bank and the Federal Reserve, the outlook for European equities appears increasingly robust.
This awakening of European markets may not be a mere rebound from the depths of despairIt is indicative of an enduring paradigm shift, as posited by Mizuho strategist Jordan Rochester's recent call to "Make Europe Great Again." In times of rising anxiety, there has been a swell in calls for a stronger strategic autonomy within Europe, a sentiment echoed by French President Emmanuel Macron, who has articulated the necessity for Europe to "awaken" in light of the tumultuous international landscapeHis New Year’s speech in 2025 echoed a vision of a comprehensive response across scientific, technological, industrial, agricultural, energy, and ecological spheres.
The complexities surrounding the European Union in the wake of a new U.S. administration have revitalized discussions around a pivotal report released last year by former ECB President Mario Draghi, titled "The Future of EU Competitiveness." Many European decision-makers have turned to this report amid a range of internal challenges affecting the Union, particularly the impediments posed by the insufficient integration within the EU framework.
Draghi had previously urged European policymakers to eliminate extensive regulations that hinder the operation of the EU internal market
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A chorus of contemporary voices now echo his sentiments, as central banks from Germany, France, Italy, and Spain united in requesting the EU executive to relax new bank capital requirements that would come into effect in January.
An important area of reform that the EU is currently examining concerns the ability of its banks to place more assets off their balance sheets, a significant need given that Europe's securitization issuance is an astonishing 1/13th of that of the U.SPresently, several intra-European mergers and acquisitions are facing roadblocks that could easily be resolved by regulatory adjustmentsFor instance, the attempts by Italy's Unicredit Bank to acquire Deutsche Bank have been subject to scrutiny and hurdles originating from regulatory oversight.
In recent times, former struggling lending institutions in the Eurozone, such as Unicredit and Sabadell, are undergoing profound reassessments as their valuations start to reflect higher than book value prices — a scenario previously considered unimaginable just a year agoWhile large investment banks like Deutsche Bank and BNP Paribas are still perceived as carrying significant valuation discounts, the future may hold transformative reforms for the banking industry, which could positively influence their market standings.
Draghi has also promoted the development of critical industries, particularly electric vehicles and semiconductorsJust days ago, the European Commission approved a substantial aid package worth €920 million to support Infineon Technologies in establishing a semiconductor manufacturing plant in Dresden, GermanyThis initiative further exemplifies a potential modern renaissance for European industries, marrying ambitious policy with responsive infrastructure investment.
As Europe navigates these complex waters, balancing internal challenges with external pressures from global markets, the awakening of its stock market could very well signal a redefined narrative for the region's economic future, presenting opportunities for investors and a renewed sense of confidence in European assets.
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