- Recession expected
- US subsidies response needed
A year on from our last Europe outlook, the energy crisis and elevated inflation remain the central issues for the continent. These problems have increased in severity several times over because of Russia’s invasion of Ukraine and the impact of the war on utility prices and supply chains. And an additional headache for 2023 has emerged in the form of trade hostilities with the US, as western nations battle over subsidies and attracting capital flows into the green tech companies of the future.
But despite geopolitical and economic trade headwinds, there are still attractive investment options in Europe. The continent looks notably cheap – European equities at their largest discount to US stocks in over five years, according to Jupiter Asset Management fund managers Mark Nichols and Mark Heslop, a position they consider “extreme”.
Inflation and monetary policy
Eurozone inflation has been driven upwards by soaring energy and food costs. The situation has been exacerbated by cutting off Russian gas supplies, which European nations had been reliant on. This process is continuing – the European Union (EU) has banned Russian seaborne oil imports, and an oil price cap has been set.
The good news is that citizens and corporates have been cutting back on energy demand, wholesale gas prices have fallen and storage levels have been built up. It is winter 2023 that looks like more of a challenge.
As in the UK, the energy situation has boosted utility giants. French exploration and production company TotalEnergies (FR:TTE), for example, is up 29 per cent over the past 12 months. But we think next year is unlikely to see another huge energy stock outperformance – something for investors to bear in mind.
While annual eurozone inflation fell to 10 per cent in November, this was only down slightly from a record high of 10.6 per cent the previous month. There is little expectation that it will get back to the 2 per cent target any time soon, although Goldman Sachs analysts forecast that it will peak this month and that core inflation (currently 5 per cent) will fall to 3.1 per cent by the end of 2023.
The inflation situation means the European Central Bank (ECB) is set to raise rates further. And it is also set to start slowly cutting down its €5tn (£4.3tn) balance sheet. Pictet Asset Management strategists think that the ECB will replace the Fed as the “major source of policy tightening” next year.
Higher borrowing costs will put pressure on households and companies, and will highlight differences in debt levels between euro members, which is always uncomfortable for the bloc.
The consensus among economists is that the eurozone will shortly enter recession, although there are differing predictions on the severity. Capital Economics chief Europe economist Andrew Kenningham is bearish – he expects a 0.7 per cent contraction in eurozone gross domestic product for 2023 as a whole. Germany, which has been hit hard by the energy crisis, faces a much more challenging time than France, according to Kenningham.
A green trade war
To the challenging macro situation can now be added more trade uncertainties. Legislation in Washington has created a risk that billions of dollars of investment could head across the Atlantic at Europe’s expense. The Inflation Reduction Act (IRA) provides $369bn (£303bn) of American subsidies and inducements in areas such as clean electricity and electric vehicles. The US suddenly looks more attractive for wind turbine, battery and solar panel manufacturers. European policymakers and analysts are aghast.
European Commission president Ursula von der Leyen said in a speech in Bruges earlier this month that “there is a risk that the IRA can lead to unfair competition, could close markets, and fragment the very same critical supply chains that have already been tested by Covid-19”. She called for a “structural answer” from the EU. What this will end up looking like remains to be seen, although state aid rules could be adjusted to boost European competitiveness.
This international strife isn’t necessarily a bad thing for stockpickers, though. Businesses such as Norway’s Equinor (NO:EQNR) and Germany’s RWE (DE:RWE) can tap US opportunities themselves: both were among the firms to successfully bid for part of the first ever US offshore wind farm lease sale on the Pacific coast earlier this month. French asset manager Carmignac says that “investment opportunities will arise from the continued desynchronisation” between Europe, the US and China. The latter’s splurge on green energy investments is the real reason for the IRA anyway. But the debate around the act has opened up geopolitical and economic difficulties within the EU, with nations such as Germany opposed to an expensive response.
Europe isn’t boring
Saying that, there is already a significant amount of cash dedicated to the green transition in Europe through various EU-wide facilities. We mentioned Spanish power company Iberdrola (SP:IBE) and Norwegian renewables purveyor Norsk Hydro (NO:NHY) in last year’s outlook and still think these companies look like good options as the green revolution moves forward, despite the challenges for the clean energy sector from higher electricity and commodity costs.
Deutsche Bank analyst Liam Fitzpatrick says that Norsk “is strategically very well positioned (integrated on power, strong balance sheet, medium term growth avenues) and we remain bullish on the medium term outlook for aluminium”.
It isn’t just green tech stocks that are attractive. Schroders European equities fund manager Martin Skanberg points to eurozone banks, capital goods and semiconductors as stocks that could “potentially provide some earnings stability” in the year ahead.
Europe is often derided as sclerotic, bureaucratic and behind the curve. But a glance at the top 10 of the MSCI Europe index should disabuse one of that notion. Consumer staples giant Nestlé (CH:NESN) tops the list, pharma giants such as Novo Nordisk (US:NVO) and Novartis (CH:NOVN) are up there, as is Dutch chipmaker ASML (NL:ASML). We are particularly bullish on Nestlé and Novo Nordisk as we head into the new year, with active Buy ideas on the pair. Despite challenges on multiple fronts, Europe still presents many exciting investment options.
