Europe’s green shoots and leavers

In geographical terms, Europe has always lacked a precise definition. Similarly, investors often mean different things when they talk about the continent. 

This partly stems from the question of boundaries. When it suggests the dominance of banks and structural issues are good reasons to ‘underweight’ European equities in 2021, BlackRock – a fund manager whose global span belies a US-centric view of markets – is also referring to UK stocks. Of course, investors north of the Channel see things slightly differently, especially now.

Then there is Europe in a broader socio-economic sense, with its ageing demographics, flatlining or declining personal incomes and stuttering labour productivity.

For others, the most useful way to think about Europe is in terms of the eurozone, given the outsize role the European Central Bank (ECB) has come to play in its markets ever since the global financial crisis. However, this classification glides over several important European Union (EU) states, and the often-messy political enmeshment of the bloc’s economies.

Despite those perennial complexities, the good news is that 2021 will start with a sense of direction, after the EU’s €1.8tn, seven-year budget was signed off. The fiscal package, aimed at fostering a green-led recovery in the wake of Covid-19’s devastating effects, had been opposed by politicians in Hungary and Poland over conditions linking payments with respect for the rule of law.

Last-minute German diplomacy led to a convoluted workaround and the sound of another political can kicked down the road. On balance, the fact that disbursements to member states still reeling from the virus can continue is clearly a short-term positive. Looking beyond 2021, fractures over values – and the appeal of further departures from the bloc, should the UK make a success of Brexit – are reasons to doubt the sudden arrival of US-level market valuations.

As with the UK and the US, the immediate outlook for the pandemic will dictate the pace of any economic and financial market rebound in 2021 (see table below). “A failure of the current restrictions to significantly reduce virus transmission in the short term would mean a slower recovery,” notes Vanguard. “Potential problems with the efficacy, adoption, distribution, or safety of a vaccine could also surface.” Granted, but the latter issues are true of the rest of the world, too.

Even if the rebound beats all forecasts, the consensus view is that inflation will remain subdued. From this, and the further descent of the yield curve into uncharted territory (even 30-year bonds now have a negative yield, as the chart shows) investors can surmise that ongoing asset purchases by the ECB are set to continue. Insofar as these programmes boost economic activity – as they have done in the past – then this should be good for equities.

European shares also remain attractive relative to government bonds. What this means in practice of course depends on the sector, size and geographical exposure of the stock in question; indeed, from an equity investors’ perspective, ‘Europe’ is as varied as the UK market. Both also share several features: a greater weighting to financials than technology, but home to some excellent, highly priced companies, many of which are returning to the dividend list. 

Like the UK, quality large-cap equities should continue to do well in this environment, buttressed by super-cheap debt funding and higher fiscal spending. From 2021 onwards, analysts at JP Morgan also believe that large-cap eurozone stocks should provide a better trade-off between compound returns and volatility than debt.

Within this group, it seems sensible to assume that companies tacking their recovery strategies to a lower- or zero-carbon future should do better, given the enormous fiscal and growing social tailwinds. Two Danish sustainability leaders selected in our 2019 and 2020 outlooks – food science firm Chr. Hansen (Den:CHR) and materials science group Novozymes (Den:NZYM) – both look well placed on this front, as does highly valued offshore wind giant Orsted (Den:ORSTED).

The potential for a rally in carbon prices next year also bodes well for three utility stocks which made last year’s high-quality large-cap screen: Endesa (Sp:ELE), Enel (It:ENEL) and Fortum Oyj (Fi:FORTUM).

Europe’s recovery from its long Covid-19 winter could well be patchy, but like all springs it will come with green shoots

Eurozone – economic outlook