Let’s not beat about the bush: the last decade has not been kind to European equities or, as one European fund manager aptly noted, they’ve endured a hangover to rival all others.
While the S&P 500 has headed inexorably upwards, Europe has faced a litany of headwinds from stagnant GDP growth and weak consumer confidence to an energy crisis and the lingering effects of austerity-driven policies.
That said, investors taking a longer-term view on Europe have historically been well rewarded. Over the past 20 years, the MSCI Europe index has delivered a total return of just over 300%, outpacing the 280% return of the FTSE All Share and not far behind the 310% return of the MSCI World (ex-US) index. More recently, it’s also chalked up a 12% return over the last year.
It would be fair to say that Europe has long suffered from the perception that ‘the EU regulates what the US innovates’ but this ignores a significant changing of the guard in European equities over the past 20 years. Where low-growth telecoms and financial services firms once dominated, European indices are now populated with innovative sectors such as semiconductors, healthcare and information technology.
Luxury goods are another driver of long-term growth in European equities, with Europe capturing two-thirds of global revenue from this sector, according to the Financial Times. LVMH, Hermès and Ferrari are globally-recognised brands with relative inelastic demand for luxury goods supporting margins that wouldn’t look out of place in the US technology sector.
As LVMH founder Bernard Arnault put it: “Can you say that in 20 years people would still use the iPhone? Maybe not. What I can say today is that, in 20 years, I'm quite convinced that people will still drink Dom Pérignon.”
One of Europe’s key selling points is valuations, which remain significantly below those in the US. The MSCI Europe index is trading at a forward price-to-earnings (P/E) ratio of just over 13x, almost 40% below the 22x P/E ratio of the MSCI USA index (as at 31 Oct 2024). Some of this discount is explained by the higher weighting of growth stocks in US indices but sector-level discounts remain compelling.
Jamie Ross, co-manager of Henderson European Trust, has spoken about Europe “being home to global champions in the ‘wrong’ postcode”.
Novo Nordisk is currently one of the trust’s largest holdings and is at the forefront of the game-changing obesity drugs with Wegovy. However, the other market leader, Eli Lilly, is trading on a P/E ratio of 63x compared to 33x for Novo Nordisk. Yet both companies enjoy significant barriers to entry in terms of their capex on manufacturing capacity, which is expected to confer a significant competitive advantage over the next decade.
Europe also offers exposure to some of the mega-trends propelling US equity valuations. ASML, another of Ross’ holdings, develops and produces advanced equipment systems for semiconductor manufacturers and is a key facilitator for the implementation of AI technology.
Similarly, hardware supplier Siemens is capturing a share of the hundreds of billions of dollars spent by the likes of Amazon, Alphabet and Microsoft on the roll-out of hyper-scale data centres.
Henderson European has achieved a 10-year NAV return of 150% and is currently trading on the second-highest dividend yield in the sector at 3.4%.
Most European funds exclude the UK in their investable universe but European Opportunities Trust offers a differentiated option with around a third of its portfolio invested in the UK. It looks for growth companies, together with significant overseas revenue, and has a long-standing focus on healthcare and technology.
The trust has held Novo Nordisk for over 20 years, helping to drive a 10-year NAV result of 100%, although the managers have trimmed their position over time to avoid over-concentration of the portfolio.
Alternatively, The European Smaller Companies Trust is the largest and most liquid trust in the AIC European Smaller Companies sector.
European small-caps offer somewhat of a double discount, with small-caps trading at a substantial discount to European large-caps (or indeed a triple discount given that this trust is also trading at a 4% discount to NAV).
Thanks to the relatively limited research on smaller-caps, the trust’s managers at Janus Henderson Investors see Europe as a fertile hunting ground for stock-pickers, looking for companies across all stages of the corporate life cycle.
Given the higher risk nature of the smaller end of the market cap spectrum, the trust holds a well-diversified portfolio of around 130 stocks and has achieved a 10-year NAV return of 240%.
Looking forward, investors will no doubt be looking for the likely catalysts to close this valuation gap. The macroeconomic environment is looking more supportive, with the European Central Bank cutting rates on the back of falling inflation but share prices can be as much a function of company-specific as macro factors.
Europe continues to offer world-leading companies with substantial overseas revenue, together with greater sectoral diversity than the US. If fund flows into US equities grind into reverse as valuations continue to climb, European equities could well reap the rewards.
Jo Groves is an investment specialist at Kepler Partners,. The views expressed above should not be taken as investment advice. All data is to 11 November 2024 unless otherwise stated.