By Marcus Morris-Eyton, manager of the AllianceBernstein European Growth Portfolio
Investors in Europe have had few reasons to cheer in recent years amidst a market rally that has been heavily concentrated around the US. This is reflected in a record 40% valuation discount between Europe and the US equity market.
Finding asset allocators who are not overweight the US and underweight Europe has become something of a rarity in recent years – and rightly so. European equity ownership weights having fallen to 5% relative to a 14% benchmark weight in the MSCI ACWI.
This negative sentiment has not been helped by the speculation of new tariffs from the Trump administration. However, European equities have started 2025 strongly, and with such extreme valuations combined with cyclical data gradually recovering, could Europe finally be heading for a resurgence?
The missing catalyst
Valuation has often been the primary argument in favour of Europe. No doubt, Europe does look attractively valued relative to the US, with the aforementioned 40% discount between MSCI Europe and the S&P 500 being double the long-term average.
The regular and justified pushback to this is that the market structure is very different, with the US having far greater exposure to the technology sector, whereas Europe is more exposed to banks and commodities.
See also: Euro vision: What Europe’s valuation discount means for investors
However, even after adjusting for these differences in sector composition, Europe still trades at a 20% discount to the US on a like-for-like basis. The trouble with valuation-based arguments though, is that a catalyst is needed to close the gap, which has been lacking in Europe.
January saw the first month of inflows into Europe since the beginning of the Russia-Ukraine war. And perhaps more markedly, we also saw the second-largest positive shift in sentiment to European equities in history, according to a recent Bank of America Fund Manager Survey. So are these positive catalysts finally emerging?
Optimistic macro
The macro data is supportive. Both cyclical data and earnings in Europe are holding up much better than many feared. During fourth-quarter earnings season, the average European company beat consensus earnings expectations by 3%.
European companies are now also seeing more earnings upgrades than their US peers, with earnings growth expected to accelerate through 2025. The weaker euro is acting as a welcome tailwind for many companies, especially those with international revenue exposure.
See also: AllianceBernstein launches US large-cap portfolio for Europe
And with inflation more muted, the path to further interest rates cuts looks perhaps clearer in the Eurozone than in the US, with the market expecting 2% interest rates by the autumn.
Does macro matter?
However, macro debates often matter much less than many people assume. Over the last five years, European economic growth has no doubt been lackluster with GDP growth averaging less than 1%, but that doesn’t mean you can’t find growth in the market.
Companies with market leading products or services, strong management teams, good pricing power and established barriers to entry, are generally in control of their own destiny rather than being at the behest of the macro environment and politicians. Despite being listed in Europe, many companies pivot growth to where demand is coming from, often with most of their revenues coming from outside Europe.
The benefit of this investment process is perfectly illustrated through the debate surrounding tariffs in the US. European companies, much like all regions, are facing a raft of new challenges from the policy direction of the new Trump administration. But select European companies with the right business attributes will do well during the new regime.
See also: European markets boosted by defence stocks
European companies generate 20% of sales from the US on average, but it is estimated only one quarter of that is goods exported to the US (with the rest being either services or products made in the US for the US). The exposure obviously varies significantly by sector, with sectors such as autos, MedTech and luxury goods being the most exposed to the US.
While many companies will suffer from the introduction of any tariffs, we believe that the debate is more nuanced than is presented by most market commentators, with the precise impact varying hugely from company to company. For equity investors in Europe, the challenge is to identify companies that will be able to compete effectively despite the higher hurdles.
Companies with strong pricing power and local-for-local operations, for example, will be much less vulnerable to potential tariffs and can indeed actually turn the trade wars into an opportunity to increase market share versus other international peers.
We think that investors, by using clear criteria for finding high-quality growth businesses, can identify companies that are more likely to overcome policy-driven obstacles and to defy pessimism over the plight of European markets.