Europe was the proverbial ‘game of two halves’ for retail investors in 2024. Positive sentiment at the start of the year as the IA Europe ex UK sector attracted net inflows of £1.65bn between January and July turned into net outflows of £727m from August to November.
The decline in sentiment in the second half of the year was no surprise given the political turmoil seen in the eurozone and, towards the end of the year, concerns about tariffs threatened by the incoming US President Donald Trump.
Indeed, reflecting these tariff concerns, 2025 consensus GDP growth forecasts for the eurozone have been downgraded marginally to 1% from 1.2% since the US elections in November.
James Flintoft (pictured left), head of investment solutions at AJ Bell, and Will James (pictured right), manager of the Guinness European Equity Income fund, share their views on the region for the year ahead.
James Flintoft, head of investment solutions, AJ Bell Investments
‘The US innovates, the EU regulates’ is often used to describe the different dynamics in these two regions. But is this characterisation too clumsy when it comes to equity markets?
While it may hold true for political and regulatory bodies, a quick glance at major European equity indices reveals several global leaders.
Moreover, these companies often trade at valuation multiples that are comparable to their US peers.
ASML, the producer of the massive machines required to make chips – the AI kind – and Novo Nordisk, the pharmaceutical company behind the barnstorming weight-loss drug Wegovy, are just two examples. The list continues with SAP, Nestlé, Roche, Novartis and LVMH – all global businesses with European origins and listings.
Not only are some of these businesses similar to their US counterparts, but so too are some of the index dynamics. Both US and European indices are concentrated, though to a greater degree in the US. This means the valuation of mega caps has less impact on European indices, which is the first reason why Europe, in aggregate, appears ‘cheaper’.
Secondly, the ‘tail’ of stocks in Europe tends to consist of smaller companies by market cap. These smaller companies are often more domestically oriented than the mega caps, further contributing to the perception of ‘cheapness’ at an index level.
Underdog status
Recently, the US economy has powered ahead, while Europe has faltered – again. This divergence can be a strong driver of market performance. A poorly performing economy is often associated with underperforming companies and stockmarkets.
Add to this a dose of political uncertainty, potential Trump tariffs, scars from the eurozone crisis and narratives about monetary policy keeping ‘zombie’ companies alive, and it is easy to see why allocators would prefer to stick with the US market.
For a US-based investor considering an allocation to Europe – a relatively small part of the global equity universe – there’s little incentive when their home market has been so rewarding.
Despite these challenges, fund manager surveys show growing enthusiasm for European equities, although it is far from a strong consensus trade. We also view Europe as an interesting opportunity set, and while our portfolios are naturally diversified, this year we’ve increased our European holdings to take advantage of lower aggregate valuations.
For passive portfolios, we implement this through a combination of the Xtrackers S&P Europe ex-UK ETF and the Vanguard FTSE Developed Europe ex-UK fund. The ETF provides quick market access, which is important for our daily dealing fund range.
Our income funds use two quality dividend ETFs from iShares and Franklin Templeton. We favour screens that prioritise quality income – mainly dividend persistence – rather than chasing high yields that may lead to value traps. The yield paid on these strategies is often broadly in line with the wider European equity market.
On the active side, we take a blended value/growth approach with split weightings between Rob Burnett’s Lightman European fund and Giles Rothbarth’s BlackRock European Dynamic fund.
The Lightman fund benefits from its clear value philosophy and a boutique environment, whereas the BlackRock fund is supported by a huge team of analysts with superior cashflows and earnings.
Within our active income MPS, we combine the high-yielding Lightman European fund with the ‘core’ approach of the BlackRock Continental European Income fund, where we retain conviction despite the recent retirement of the manager. Finally, for our Responsible MPS we continue to hold the Amundi MSCI Europe SRI PAB ETF.
Overall, Europe undoubtedly faces challenges – but there are opportunities for those willing to stray from the herd.
Will James, portfolio manager, Guinness European Equity Income fund
European equities had a promising start in 2024 on nascent signs of an improvement in economic data, improving business and consumer sentiment as inflation started to dissipate, and measured monetary easing.
However, as is often the case with Europe, political turbulence (this time in France) gave investors pause for thought and by the time the fourth quarter had arrived, any hope of making a case for Europe, beyond ‘it can’t get much worse’, was well and truly ‘Trumped’.
However, while the reasons mounted as to why it was sensible to avoid Europe – politics, slow growth, the ‘known-unknown’ risk of US tariffs, US exceptionalism etc – there have been several interesting and positive developments which appear to have been ignored by the market.
First, while the political machinations in France saw sovereign risk increase, and with it, flashbacks of the torrid years of the sovereign debt crisis, there was no contagion or any signs that the market was truly concerned. While bond spreads increased in France, they continued to fall in Italy.
Why? In simple terms the market appears more interested in political stability versus political ideology at the moment. While France struggles politically, Italy’s Georgia Meloni and her right-wing government is in control and, as a result, the Italian equity market has been one of the best-performing in Europe since Meloni’s ascent to power in 2022.
Second, while the economic backdrop has not made things any easier, the mass exodus of investors from Europe in 2024 left valuations relative to the US (even accounting for differences in sector composition) at levels last seen during the eurozone crisis: as cheap as they have been in more than 10 years.
A PR problem?
Encouragingly, the valuation of European markets has not gone unnoticed, and equities have made up some, if not all, of their losses from the fourth quarter of 2024. However, cheap is not the same as undervalued. So, Europe needs to start showing what it is capable of in the face of a revitalised president Trump and address the negative perception investors currently have.
The chances of a coordinated policy response appear to be growing. Mario Draghi’s report on European competitiveness from late 2024 put forward a roadmap for European policymakers to begin following in 2025. In fact, the European Commission only this week has suggested it will adopt some of the proposals.
Christine Lagarde has stressed the urgency of capital markets reform, highlighting the “extraordinarily fragmented” nature of Europe’s financial markets. Interestingly, M&A in the sector has picked up of late.
As to politics, the market will watch the German election in late February with interest. If the polls are to be believed, the CDU/CSU alliance led by Friedrich Merz is likely to be able to form a coalition. This would be taken well by markets as Merz has argued for less regulation, less bureaucracy and lower taxes to boost growth, and has indicated that he would be prepared to amend the debt brake to fund increased investment in infrastructure and defence.
As ever with Europe, the journey will be bumpy and take a bit longer than expected. However, a combination of renewed political clarity and stability, attractive valuations and a concerted effort on the part of Europe to imitate, innovate and perhaps regulate less, should improve the backdrop for European equities in 2025 markedly and would be greeted with great fanfare.
This article was written for our sister title Portfolio Adviser’s February magazine
