Making the pitch for Europe has been, to put it mildly, challenging over the course of 2022. Those bearish on Europe’s near-term prospects – and it isn’t particularly difficult to find them – have had no shortage of factors at which to point. This year alone we’ve had the tragic war in Ukraine, a gas crisis, spiralling inflation and political convulsions. Against this backdrop, any attempt to highlight the historic cheapness of the European market has fallen on deaf ears.
One need only look at market positioning to get a sense of what investors are pricing in. Euro/dollar weakness is relentless. Equity markets are nearing their March 2020 valuations low, a period when Covid-19 newsflow was at its most severe. Flow data – where money is moving from/to in the market – is at its worst in six years. Furthermore, investors typically pair these short-term concerns with the conventional view that Europe is an ‘old’, cyclical economy that lacks domestic growth. It’s no wonder one commentator said that interest in Europe was “next to zero”.
We don’t disagree that the near-term outlook is challenging. That said, it’s notable that European governments are following the UK’s lead in providing material fiscal backstops. There are also signs that policymakers are able to cut gas demand without significantly diminishing industrial production. This might lower the risk of energy rationing, at least until the end of this year.
And what about the ‘structural’ argument against Europe? Here, we strongly disagree with the critics. Indeed, there are three key reasons why we think Europe’s prospects are far brighter than they’ve been for some time.
Three reasons to keep the faith with Europe
First, there are numerous companies successfully combining Europe’s enviable heritage and history with cutting edge innovation and technology. Second, the continent continues to build on its strengths in sustainability and green technologies. And finally, investors still underappreciate Europe’s growing strengths in industrial digitisation.
Within these segments, there are companies across the continent with strong, competitive market positions that benefit from structural growth tailwinds. Many successful firms are consistently boosting their earnings power or returning generous levels of capital to shareholders. We believe these factors will be increasingly important in a world where low interest rates and low inflation are no longer the primary drivers of asset prices. It also means these businesses are well placed to face the many headwinds buffeting today’s markets.
Thanks to its long heritage in artisan manufacturing, Europe is home to world-renowned luxury businesses such as Hermes and LVMH. Meanwhile, the continent’s industrial strengths have borne companies like Dassault, Nemetschek and Schneider. Increasingly, these businesses are matched with Europe’s expertise in business leadership, covering areas like payments, industrial automation and internet platforms. We think this balance is one of Europe’s understated and undervalued strengths. For investors, these companies are a great opportunity to own businesses with a diverse range of structural drivers across a range of industries.
Responsible investment – leading the charge
We’ve also long believed that Europe is the global centre of responsible capitalism. Indeed, the idea that sustainable profit and sustainability are mutually reinforcing dynamics was born and nurtured in Europe. Policymakers have also driven the agenda. In December 2019, Europe announced a €1 trillion Green Deal. For many, this represented a culmination in public and fiscal support for, and the private sector’s global leadership in, green technology and the energy transition. Given its sheer size and scale, the deal was dubbed “Europe’s man-on-the-moon moment” by European Commission Chairman Ursula von der Leyen.
The war in Ukraine has complicated matters. For some, the conflict has compromised Europe’s green agenda. After all, price often drives the narrative. Oil & gas companies are benefiting from record prices. Defence companies are reporting burgeoning order books. As a result, some FOMO investors have rushed to recategorise and reformulate the ‘E’ in ESG. Policymakers are also trying to balance their green agendas with the immediate need to keep the lights on.
Nonetheless, we think these debates around nomenclature will be short lived. Not only are Europe’s green ambitions unchanged, they are now fully aligned with its ambitions to achieve energy sovereignty. Europe’s impulse to break away from the previous energy regime – and to drive the transition to renewables – is therefore materially stronger in 2022 than at any time in the last decade.
A digital revolution
Prior to Covid-19, the drivers of computing growth were shifting away from the mobile internet and the consumer towards the digitisation of industry. The pandemic accelerated this transformation. Europe’s Industrial Revolution, has numerous manufacturing-centric economies. Building on this legacy, many are now at the heart of industrial digitisation and automation. IT spending in manufacturing continues apace. From industrial software and semiconductor firms, to market leaders in robotics and automation – the prospects for numerous European companies has markedly improved.
So it is despite, or rather because of, the pervading market pessimism that we think Europe is an interesting proposition. Investors just need to look beyond the headlines. When they do, they can find some of the best companies in the world trading at extremely attractive prices. They can also find emerging leaders in structurally growing industries. Famed investor Seth Klarman spoke of the importance of investing when one enjoys a ‘margin of safety’. Given the current climate, we think Europe now offers this margin with room to spare.