After a decade of unattractive returns, eurozone equities are once again of interest to many market players.

Everything, despite the great uncertainties that are planned in the markets, among which is the evolution of the pandemic or inflation. For now, the MSCI EMU Index of the 10 Developed Markets of the Economic and Monetary Union is up 16% in dollar terms this year, compared with 9.7% for the MSCI All-Country World ex US Index.

In fact, in local currency terms, Eurozone equities have risen as much as their US counterparts. So why has investor interest in this area increased? Here are four emerging trends in Eurozone equities that may surprise you.

Many sectors of the “old economy” no longer have the capacity to obtain profitability. The eurozone is often seen as offering high market exposure to “old economy” sectors such as financials and low exposure to growth-oriented sectors such as technology.

However, while this was true in its day, it is no longer true. In the last decade, the weight of the market capitalization of technology stocks in the euro area has tripled, from 4.5% to 14.3%. This has made technology companies the third most important sector in the region. Meanwhile, the financial sector has seen its weight plummet by 11.1%, from 25.2% in 2010 to the current 14.1%.

From a “value” to a “growth” bias

A recent report by Schroders points out that one of the consequences of the change in the configuration of sectors in the eurozone is that growth values. In other words, those with above-average expected earnings growth have become a stronger source of earnings. For example, 78% of consumer discretionary stocks (the largest sector in terms of market capitalization) are classified as growth by index provider MSCI. The information technology sector also has a strong growth bias.

“On the other hand, the sectors least exposed to the style of growth (the financial sector, public services and energy) are also the ones that have shrunk the most in proportion to the market,” says the British manager. This change is important because one of the main reasons for the low profitability of the eurozone in the last decade has been its low exposure to fast-growing companies. In fact, the best-performing sectors in the eurozone have been growth-biased, while the worst-performing sectors have been value-biased.

Schroders European equities manager Martin Skanberg comments that the profile of the eurozone “has changed in recent years.” The region is home to many innovative and fast-growing companies, but “investor perception has not necessarily matched that reality.” There are numerous companies in the eurozone that are leaders in the fight against climate change. These companies “will see increased” demand for their products and services due to “the imperative to meet climate goals.”

In his view, it is not only about companies that operate in the generation of energy, but also, for example, suppliers in the materials or industrial sectors that are helping to create more efficient and environmentally friendly products. There are also the technological leaders.

Prominent among them are semiconductor equipment companies, which are well positioned to benefit as the world digitizes and chipmakers increase capacity while seeking to offshore supply chains. “On the other hand, we can also point to the health sector, in which Europe is the world leader; an example is the novel mRNA vaccine that is no longer only used for Covid vaccines, but will allow a new range of immunotherapies in the near future”, he assures. “Many of the components and equipment are supplied by European companies,” he adds.

Along these lines, in Europe there continues to be a significant fiscal stimulus after the pandemic, with special attention to the EU’s Next Generation plan, endowed with 750,000 million euros. This plan is designed to build a greener, more digital and more resilient Europe. Companies whose products and services can make this a reality should continue to see strong demand.

After a difficult 2020, the eurozone is experiencing a rebound in earnings expectations. For example, the 13-week earnings review ratio (upgrades vs. downgrades) has risen faster in the eurozone than in the rest of the world. “Historically, whenever analysts have been relatively more optimistic in their assessment of expected returns, eurozone equities have outperformed global equities,” Schroders specifies.

Eurozone valuations have appreciated

With earnings forecasts being revised upwards and the sector composition improving, investors are gradually reassessing the investment case for the euro area. For example, based on a future PER, the MSCI EMU Index now trades at an increasing premium to other non-US markets (MSCI All-Country World Index ex US/EMU). “This is a positive change, as better growth prospects should justify a higher valuation,” says Skanberg.

Eurozone valuations have not declined compared to the United States, where the technology sector has more weight (29% of the index) and where there is a greater inclination towards growth. However, when looking at analysts’ earnings expectations for 2022 and 2023, we find that the Eurozone is expected to grow at a similar rate to the US (around 9% per year), which suggests, in the manager’s eyes , that there may be room for valuations to continue to rise.

The manager of the British firm affirms that so far it has been “a positive year for corporate profits”. However, price pressures are showing up on several fronts, including logistics and transportation, as well as rising raw material costs. Demand has been so high that most industries can “just pass on these increased costs, but some areas are starting to feel the pinch.”

Investors will have to be selective in choosing those companies that have pricing power and can protect their profit margins. The end of deflation is real, and rising costs are becoming more endemic throughout the economy. “The increase in wage expectations will probably anchor higher inflation,” he says.

Ultimately, central banks will have to alter monetary policies, with profound implications for asset allocation. “Of course, a new set of winners will emerge, but the equity playbook of the last two decades may well have to be read backwards,” he concludes.

Source: https://www.lainformacion.com/