Piecing together Europe's economic jigsaw

By Simona Paravani-Mellinghoff, Global CIO of Solutions, Multi-Asset Strategies & Solutions (MASS), BlackRock, and Ann-Katrin Petersen, CFA, Chief Investment Strategist for Germany, Austria, Switzerland and Eastern Europe, BlackRock Investment Institute

This year was expected to be a turning point for Europe’s economy. The continent has made steady strides out of the energy crisis and is experiencing a promising uptick in growth. Inflation has finally eased, albeit with some expected fluctuations, allowing the European Central Bank to start cutting rates. That would normally pave the way for a more vibrant economic climate. However, the latest global market sell-off – prompted by a combination of US recession fears, concerns that the rally in tech stocks might be overblown, and the unwinding of a popular yen-funded trade – suggests that we’re not out of the woods yet. Can these bouts of intense volatility derail Europe’s budding recovery?

We think that US recession fears are overdone and stick to our view that AI is a mega force with the potential to reshape economies in the long term and boost multiple sectors. We also see several factors playing in favour of the EU economy. Earlier this year, we noted that resurgence trends across Europe were far from uniform but nonetheless consistent enough to justify a cautiously positive outlook – and this still holds true. The revival looks set to be largely driven by European consumers, who are finally experiencing a bit of extra spending power after a long period of wages barely keeping up or falling behind inflation. Generous stimulus measures delivered through the NextGenerationEU recovery plan and the EU’s long-term budget, amounting to over €2 trillion¹, have also played a role.

Beyond AI and digital transformation, there are other structural mega forces supporting the ongoing economic rebound.  Europe's commitment to the low-carbon transition and the potential windfall from manufacturing's homecoming are capturing investors’ attention. And defence — a sector that has been on an austerity regimen for years – is now poised for a robust comeback, heralding a new era of innovation and investment opportunities.

But let's not don rose-tinted glasses just yet. The continent's workforce is aging, energy security remains a high-stakes game, and geopolitical fragmentation is deepening, fuelled by a surge in populist sentiment across Europe. Additionally, European businesses struggle to grow, hampered by insufficient capital investment, partly due to the limited breadth and depth of European capital markets.

What can European investors make of this complex jigsaw? The August market jitters demonstrated that the post-pandemic world is anything but predictable. The investment landscape has outgrown the confines of traditional scripts so it’s critical to switch off the autopilot and carefully evaluate geographies and sectors to build resilient portfolios. Our analysis highlights a few considerations worth keeping in mind throughout this process.

European stocks are beginning to look like undervalued opportunities in the global market, positioning them favourably against their American counterparts. Should early growth signals persist, inflation remain tame and the earnings recovery continue, these stocks could attract more attention. Of course, this also hinges on the broader macroeconomic landscape continuing to improve and US recession fears being put to bed.

Financials, particularly European banks, are boasting solid earnings and delivering attractive returns to shareholders. We also see potential in Europe’s healthcare sector, as an early adopter of AI and a beneficiary of aging populations across the continent. European technology is another bright spot to watch. However, savvy selection is crucial, given the wide disparities within the sector and the impact of US tech stocks, particularly the so-called “Magnificent 7” i.e. Apple, Microsoft, Alphabet, Amazon, Nvidia,

Tesla, and Meta. It’s worth noting that even in industrials, the top performing stocks have been tied to data centre AI supply chains.²

Finally, European markets have been closely monitoring major political developments this summer. The EU-wide elections delivered some surprises, but the re-appointment of Ursula Von der Leyen as the European Commission’s President signifies continuity and sought-after stability. In the UK, the Labour party's convincing victory paves the way for a clear policy path, with growth seemingly the main focus for the new government. Meanwhile, the French elections produced less definitive results and negotiations are ongoing to form a government. However, political uncertainty in France is more of a localized issue than a systemic one for the Eurozone, as the French constitutional framework allows for key policy decisions – like passing the budget – even in the absence of a government. This autumn, the spotlight will be on the consequential elections in the US, as investors are waiting to see how the outcome will influence fiscal policies, trade relations, and geopolitical priorities of the world's largest economy.

Europe’s economic recovery remains a multifaceted story, framed by a mix of well-founded hopes, notable vulnerabilities and multiple caveats. Investors will also be attuned to the possible recurrence and intensity of the risk-off sentiment that rattled global markets in August and will be looking to see if the current challenges can become a political catalyst for sustained growth and competitiveness. With the macroeconomic and political landscape still in flux, keeping an eye on emerging trends might be the key to unlocking opportunities which can arise amidst uncertainty and change.

Disclaimer

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of September 2024 and may change as subsequent conditions vary. There is no guarantee that any forecasts made will come to pass.