It’s commonplace to think of Europe as a laggard when it comes to economic growth compared to the rest of the developed nations, but things might already have got as good as they are going to get, at least in the short term.
Things have started to pick up recently, as value stocks or the more cyclical, old economy sectors, which are the best represented in the European market, have performed well.
Yet, while these types of assets had a good run in 2022, investors shouldn’t be surprised if their momentum stalls in the new year, according to Paul Markham, manager of the BNY Mellon Sustainable European Opportunities fund.
“Europe had its moment in the sun when the market rotated into more value-oriented areas at the beginning of the year,” he said.
This worked in Europe’s favour as the market is predominantly made up of traditional value sectors such as retail, banks, oil and miners.
But he argued that even if the value rotation does continue, it will not have the same prolonged run of success as the growth bull market of the past decade, and that both strategies are likely to flip-flop “quite frequently”.
It would help “if Europe were a bit more like the UK”, he argued, as the domestic market was able to diversify in the 1980s and is now more vibrant than its continental counterpart.
“When I say that, I think of the contract between society, government and the corporate sector. The roots of where most economic growth has come from for the two areas were similar until they started to diverge in the 1980s, when the UK went down the route of services, in particular financial services,” he explained.
In the following 30 years, the UK hasn't been as liable to the imposition of regulatory red tape or unionisation, which was curbed by the Thatcher government, he noted.
“On top of that, the education systems, especially in continental Europe, haven't adapted to modern industrial structures and a lot of people qualify with very prestigious degrees in civil engineering rather than electronics and other areas that would help to close the gap between us and the US,” the BNY Mellon Sustainable European Opportunities manager added.
The composition of sectors in the two markets is not the only differentiator, however. Europe has a greater reliance on exports, which makes it much more vulnerable to a recession in other parts of the world such as the US or China.
“If we do see a deep recession in China or the US, that is going to negatively impact European markets. But markets still seem to be quite sanguine that we will have a short and shallow recession in the US, in which case, European equities should do okay,” said Markham.
Additionally, the war in Ukraine has had a much bigger impact on the European market and is “a much more immediate problem” for investors.
“It is likely to provide some quite depressing headline numbers around European economies. Unfortunately, Europe will be dependent on whether or not the geopolitical situation improves, but most bad news is already priced in,” he said.
Although the Ukraine invasion has been rightly the centre of attention, other political developments in the EU could play a role next year.
“We still have tough issues regarding some leaders in the EU, notably in Hungary, but the Italian government is controversial too. Clearly, the Italians are going for more hardcore policies in certain areas that could be big headline grabbers. Although I think ultimately, they'll be pragmatic,” he said.
This makes investing in Europe a challenge, but Markham mentioned renewables, in which “Europe has become a leader”, and high-end goods, which “will do well if we do get a recovery” as pockets for optimism.
Performance of fund over 10yrs vs sector and index
Source: FE Analytics
The automobiles and financial industries are “mixed bags”, as the former needs to keep pushing forward to stay on top of the American and Asian competition, and in the latter, “European banks haven’t achieved very high multiples”.
“I will continue to feel that the more industrially-related stuff and consumer goods will be positive and remain the best bets going forward,” he concluded.