Stefan Gries, manager of the BlackRock Greater Europe Investment Trust gives his perspective on the year ahead.
2023 was another eventful year in European stock markets: investors had to navigate intense speculation over the path of interest rates and inflation, fears over recession, a weak revival from China and a banking crisis. Ongoing geopolitical tensions adding to a difficult backdrop.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
However, the year turned out a lot better than most market participants had feared. An energy crisis in Europe did not materialise, inflationary pressures ebbed, and by the end of the year sentiment had picked up on the hope of central bank rate cuts in the year ahead.
European economic growth
Looking to 2024, while there remain a number of challenges, there are reasons to be optimistic about the Eurozone economy. Inflation appears to be on a sustainable downward trajectory. There may be volatility in month-to-month data, and wages may provide further pressure, but on balance, we believe the economy can handle these levels of inflation.
This means interest rates are likely to be at their peak and, at some point during the year, are likely to fall. Mortgage rates have already started to fall in many European countries. This eases pressure on households.
The corporate sector in Europe also appears to be in good health. There is limited corporate debt, margins are strong, and to date, there has been no need for major layoffs. The end of the destocking cycle is in sight across most industries.
This is also good news for the consumer: a supply chain and energy crisis that is easing significantly, combined with high employment numbers, and falling inflation suggest that the cost-of-living crisis has eased. The region is now seeing significant growth in real incomes.1
European stock market investment
In spite of this relatively benign backdrop, European equities have been under pressure since the Russian invasion of Ukraine in February 2022. While central bank action, geopolitics, and elections will doubtless consume the airwaves in the year ahead, the opportunities in European markets are broad.
We find a significant number of European equities trading extremely cheaply relative to their long-term averages for consideration in the BlackRock Greater Europe Investment Trust. This, in our view, can provide a wider opportunity set for investors. However, while a peak in interest rates is likely to support overall market levels, this will not be sufficient to identify areas which might outperform.
As always in Europe, it is key to remain selective. Long-term structural trends and large amounts of fiscal spending via the Recovery fund2, Green Deal3 and the REPowerEU4 plan in Europe are likely to drive demand in areas such as infrastructure, automation, innovation in medicines, the shift to electric vehicles, digitisation or decarbonisation.
European equity stock selection
But bottom-up evaluation of individual opportunities is crucial when investing in European companies. We continue to look at metrics such as cash flow, return on capital and earnings momentum to build a better understanding of investment opportunities. We want to find companies achieving absolute growth in their capital employed organically or through acquisitions, and those that can improve returns through better margin management.
We find more companies that fulfil our criteria on BRGE among small and mid cap companies today. European small cap equity valuations sit at a 10% discount relative to European large caps.5 Small and mid cap stocks typically underperform in the early stages of an earnings slowdown, as we witnessed through the latter parts of 2022 and into 2023, but history implies stronger momentum for these stocks during periods of earnings recovery. We believe this is likely to be the backdrop for the year ahead.
European equity valuations are attractive versus history and especially versus US equities. Overall, evidence of a resilient consumer, healthy corporate sector and decent outlooks underpinned by green stimulus, giving us confidence for the year ahead.
Sources:
1 IMF - Europe’s Wage Rises Are Aiding Recovery but Economies Face Risks - November 2023
2 The Recovery fund is a €800bn plan designed to transform European economies in the wake of the pandemic, creating new industries, opportunities and jobs - https://commission.europa.eu/strategy-and-policy/recovery-plan-europe_en
3 The Green Deal is a set of proposals to make the EU's climate, energy, transport and taxation policies fit for reducing net greenhouse gas emissions by at least 55% by 2030, compared to 1990 levels - https://commission.europa.eu/strategy-and-policy/priorities-2019-2024/european-green-deal_en
4 The Repower EU plan was launched in 2022 in the wake of Russia’s invasion of Ukraine. It is designed to save energy, produce clean energy and diversify the region’s energy supplies - https://commission.europa.eu/strategy-and-policy/priorities-2019-2024/european-green-deal/repowereu-affordable-secure-and-sustainable-energy-europe_en
5 MSCI - MSCI Small Cap index - 31 January 2024
Risk warnings
Investors should refer to the prospectus or offering documentation for the funds full list of risks.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.
Description of fund risks
Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Currency Risk: The Fund invests in other currencies. Changes in exchange rates will therefore affect the value of the investment.
Emerging Markets: Emerging markets are generally more sensitive to economic and political conditions than developed markets. Other factors include greater 'Liquidity Risk', restrictions on investment or transfer of assets and failed/delayed delivery of securities or payments to the Fund.
Gearing Risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
Liquidity Risk: The Fund's investments may have low liquidity which often causes the value of these investments to be less predictable. In extreme cases, the Fund may not be able to realise the investment at the latest market price or at a price considered fair.
