Summary

• The economic outlook for Europe in 2024 remains uncertain. Although central banks are showing clear willingness to cut rates and the likelihood of the current soft-landing dynamics continuing for the entire of 2024 has risen, slowing credit growth and signs that consumer savings are exhausted mean we continue to think recession risks are elevated and will grow as we move through the year. That said, with relative valuations at historic lows despite improving corporate fundamentals and lower reliance on domestic economies, there is room for headway to be made by European equities over the year. 
• European companies are more diversified from both a geographical and sector perspective, an important characteristic in a world with an anaemic global growth outlook.
• We believe the increased weight of the Information Technology and Healthcare sectors in European indices remarkably improves the long-term growth outlook for the region, and the potential for companies to capitalise on Artificial Intelligence (AI) advances is under-appreciated.
• ESG characteristics of European corporates remain favourable, and the theme continues to attract capital, whilst the green transition continues to disproportionately benefit Europe with its leading sustainable companies.

Market backdrop

We entered 2023 with expectations of a looming recession and all major banks signalling their intent to continue with rate hikes. During the year, there were market events including the collapse SVB and the Signature Bank in the US, the failure of Credit Suisse in Europe, underwhelming Chinese post-COVID reopening as well as rising geopolitical tensions. Despite this unfavourable backdrop, equity markets had a strong year on the back of resilient corporate performance. 

Entering 2024, the economic backdrop is still challenging. The twin pressures of sluggish top line volumes and refinancing of upcoming debt maturities at higher rates are likely to pressurise profit forecasts and will leave some companies reliant on multiple expansion for meaningful share price appreciation over 2024. We expect companies with weak balance sheets to have to raise equity over the coming months if they do not see an acceleration in fundamentals. Such recapitalisations are typically very damaging to existing shareholders. 

However, as bottom-up stock pickers we believe that there are opportunities to identify individual stocks that are attractive, particularly in an environment where the weak economic backdrop has hit sentiment broadly and valuations look compelling.
 

Why should investors consider European equities now?

Gloomy outlook already baked into valuations 

Although European companies posted strong corporate results in 2023, the effect on valuation multiples was largely muted. Asset allocators remain underweight the region and consequently European equities saw outflows for much of 2023, driving the relative valuation versus the US market to still lower levels as illustrated in Figure 1. Just a small change in sentiment in favour of the region could start to reverse the trend, and the valuation gap will potentially start to close. The rest of this article will touch on some of the tailwinds which suggest it may be an opportune time to invest actively in European equities.

Figure 1: Europe vs. US 12M Forward Price to Earnings 
 

Superior depth and breadth  

From a revenue generation perspective, the European equity market is very well-diversified and not overly exposed to the region. Less than one third of the revenue generated by European-listed stocks comes from within the Eurozone (Figure 2). Emerging markets and the US account for an almost equal proportion of sales - it is fair to label MSCI Europe a truly global index. This compares to the S&P500 index where we see a much more pronounced reliance on the domestic US market. Clearly in absolute terms the US economy is larger - but from a revenue risk perspective, diversity of earnings is an attractive and often under-appreciated benefit of investing in Europe. 

The MSCI Europe index is also far less concentrated towards the largest holdings compared to the S&P as illustrated in Figure 3. A massive c.25% of the S&P500 is concentrated in just 5 names in contrast to only 13% for MSCI Europe. Furthermore, sector exposure is more diversified compared to countries such as the US and Japan where concentration in specific sectors is more acute. The US is heavily weighted towards IT stocks whilst Japan is skewed towards Industrials and Consumer Discretionary. In Europe, exposure is far less concentrated with no sector comprising more than 20% of the index.  

As such, with superior diversification and some insulation from domestic European economics, European stocks may benefit from an improved risk-reward ratio whilst also having a cushion against global headwinds. Further, the underappreciated distinction between the European economy and company performance may have led to negative economic sentiment being disproportionately detrimental to valuations. 

Figure 2: Index regional exposure 

Figure 3: Index concentration 

Changing sector exposure  

Over the last decade or so the Financials and Energy sectors have gone from almost a combined 35% of the MSCI Europe Index to less than 25%. In the same period sectors with strong structural growth drivers, Industrials, Health Care, IT and Consumer Discretionary have increased from 30% to 50%. This changing composition of the European equity market towards sectors that are positively impacted by structural trends including digitalisation, e-commerce and aging populations is a strong bottom-up driver for higher and more stable EPS growth. 

Whilst the European equity market lacks the high-octane growth companies that have driven the US market over recent years, many of Europe’s largest companies boast very attractive attributes of low volatility growth, stable balance sheets and good dividend yields.

Figure 4: MSCI Europe sector exposure over time

Under-appreciated AI beneficiaries

Artificial Intelligence (AI) was definitely the most hyped area of the market during 2023. However, a lot of the hype was around US companies developing the large language models (LLMs), like OpenAI with ChatGPT, or providing the chips needed to run them. Meanwhile, Europe also has a group of companies that have been quietly using these emerging technologies to develop new products that are already benefitting their customers. In our view, they haven’t been getting the investor attention they deserve, as the focus is on US-listed companies at the forefront of developing the technologies. This has resulted in the European-listed beneficiaries trading at more attractive valuations. 

LLMs’ effectiveness increases with the amount of data you feed in to generate insights and, in Europe, we are fortunate to have several companies that have evolved from offline data vendors to online data and analytics providers and possess vast amounts of data. Most importantly they are only in the early stages of benefitting from the additional capabilities AI brings to the analysis and insight part of their product offering. We expect companies like Experian, Sage, SAP and RELX to be strong long-term winners in this space.

Green transition creates opportunities 

European equities may benefit from the green transition, a long-term structural driver. Europe plans to be the first climate-neutral region by 2050 whilst leading the world in wind power generation, solar technology, developing environmental projects, automation, testing and electrification. To achieve Net Zero the EU has introduced initiatives such as NextGeneration EU and the Green Deal Industrial which will drive investment, boosting prospects for leading energy companies in Europe. According to McKinsey, cumulative incremental investments to achieve net zero could reach $1.7trn by 2030 and could lead to 5 million net job creation¹. 

Europe is home to many “best-in-class” companies that we believe are well positioned to help global governments meet their net-zero emissions targets. For example, Infineon is a leading supplier of power semiconductors with >40% exposure to automotive and geared to electric vehicle (EV) production, which gives a long runway for growth as EV penetration rises to 2030 and beyond. European companies such as Sika, which sells innovative niche products to the construction and industrial sectors, are also well-placed to drive energy efficiency. Given that buildings account for 40% of Europe’s energy consumption, much of the Green Deal budget is likely to be directed towards reducing energy bills. Testing, inspection and certification company Intertek estimates that 40% of its revenues come from ESG related services and is the leader on quality assurance in solar panels.

Favourable ESG credentials 

Additionally, European companies screen the best globally from an ESG perspective, with >94% of the MSCI Europe Index assessed as A-rated or above by MSCI ESG. This compares to less than two thirds for other major world indices. As such, European equities may well benefit from lower risk including reputational and legal, providing them with a lower cost of capital. Indeed, as the investor base shifts to the millennial generation by 2030, increasing focus on ESG elevates potential reputational risks. 

Besides from a financial perspective, higher ESG scores in a world that increasingly appreciates the value of well-run, sustainable business models, the superior ESG profile of Europe may well drive future asset allocation to the region.

Figure 5: ESG rating comparison 

The key features of our European equity capability 

• Fidelity International is the largest manager of active pan-European equity funds². This provides a scale and breadth of resource that enables superior corporate access and client service. 
• Our portfolio managers draw on the expertise of Fidelity’s in-house European equity analysts: a team of 37³ sector specialists who are responsible for deep dive due diligence and work with their global counterparts to provide truly comprehensive stock coverage. 
• Our focus on bottom-up stock selection is underpinned by our focus on risk management. The search for quality is core to our investment philosophy, seeking to reduce the risks of permanent loss of capital.
• Integrated financial and ESG analysis captures the full range of fundamental factors impacting financial performance and long-term shareholder value.

² By assets under management. Refers to funds sold cross-border. Source: Fidelity International, 2023.

³ Source: Fidelity International, 31 December 2023.
 

Important Information
 
This is a Marketing Communication. This information must not be reproduced or circulated without prior permission. This information is intended for professional clients only and is not a suitable basis for the general public or private investors.

Fidelity only offers information on products and services and does not provide investment advice based on individual circumstances, other than when specifically stipulated by an appropriately authorised firm, in a formal communication with the client. 

Fidelity International refers to the group of companies which form the global investment management organisation that provides information on products and services in designated jurisdictions outside of North America. This communication is not directed at and must not be acted upon by persons inside the United States and is otherwise only directed at persons residing in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. It is your responsibility to ensure that any service, security, investment, fund or product outlined is available in your jurisdiction before any approach is made to Fidelity International.

Unless otherwise stated all products and services are provided by Fidelity International, and all views expressed are those of Fidelity International. The views expressed are as of the date of publication and are subject to change without notice. Fidelity, Fidelity International, the Fidelity International logo and the "F symbol" are trademarks of FIL Limited and are used with its permission. FIL stands for FIL Limited (FIL) and its respective affiliates. FIL Limited assets and resources as at 31/12/2023 - data is unaudited. Third party trademark, copyright and other intellectual property rights are and remain the property of their respective owners.

Certain Information ©2024 MSCI ESG Research LLC. Reproduced by permission; no further distribution. Although Fidelity International’s information providers, including without limitation, MSCI ESG Research LLC and its affiliates (the “ESG Parties”), obtain information from sources they consider reliable, none of the ESG Parties warrants or guarantees the originality, accuracy and/or completeness of any data herein. None of the ESG Parties makes any express or implied warranties of any kind, and the ESG Parties hereby expressly disclaim all warranties of merchantability and fitness for a particular purpose, with respect to any data herein. None of the ESG Parties shall have any liability for any errors or omissions in connection with any data herein. Further, without limiting any of the foregoing, in no event shall any of the ESG Parties have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. The information is as at the date of production based on data provided by MSCI. There may be timing differences between the date at which data is captured and reported. For more up to date information, you can visit https://www.msci.com/esg-fund-ratings

Investors/ potential investors can obtain information on their respective rights regarding complaints and litigation in English here: Complaints handling policy (fidelity.lu) and in German in the section “Beschwerdemanagement” (fidelity.de). The information above includes disclosure requirements of the fund’s management company according to Regulation (EU) 2019/1156.    

Unless stated differently, information dated as of February 2024.

MK16204