Europe, a contrarian investment with positive asymmetry

December 22, 2024

Kevin Thozet, Member of Investment Committee, Carmignac

The main perception is that Europe will be the main casualty of the latest US election and a Trump 2.0 administration, as the economic growth differential will be expected to further widen and the risk of renewed tariffs gaining traction weighing further on anaemic growth.

Indeed, the main concern lies with the potential for increased tariffs. The estimate is that a trade czar Lighthizer induced 10% increase on US tariffs would shave 0.5% of the Euro Area GDP over the next two years (on the assumption that Europe retaliates one-for-one). Equity markets have been quick to price further US exceptionalism postelection, while European equities are stuck at the low end of their historical valuation ranges. But such a consensual view should be tempered.

Hence, we have listed below why this bearish consensus on Europe can be challenged on the economy, and on equity markets.

The EU growth outlook: not that grim and significantly better than in 2024

The first half of 2024 saw quarter on quarter GDP growth trending at basically 0% with industry and manufacturing being the main drag on economic growth for the region. But going forward as hinted by the most recent GDP, publications point at more positive developments with signs of a long-awaited consumer spending recovery on the back of real income gains which may be beginning, and lesser savings and hoarding as interest rates are coming down in the region.

Even more so as most of the policy mix heavy lifting for 2025 will be coming from the European Central Bank (ECB) in a context where Brussels fiscal rule implies a fiscal brake on the continent of -0.5% for GDP for next year. And consensus says that deposit rates will come down from 4% a couple of quarters away to 2% or lower into 2025, this will allow for a 1% to 2% contribution to GDP.

On a final conjectural note, lower deposit rates tend to go hand in hand with a lower EUR. Such a context would allow for more competition and support – as we saw under Trump 1.0 – based on the rule of thumb that a 10% fall in the currency can add up to 0.3% to the GDP over a one-year period.

Finally, one should not discard the potential of Chinese authorities bringing forward more easing and its positive spillovers on the Euro Area, nor the capacity of European authorities to react at times of existential crisis.
As per the above, while the general perception is that the US will continue on its exceptional path (and it will likely do so) to the detriment of Europe, the reality of economic trajectories today is that the GDP growth differential between the Euro Area and the United States of America will be much lower in 2025 than it was in 2024.

On the equity front: there are long term opportunities where value meets quality

Most recent market events point at the continuation of US exceptionalism - and hence a prolonged economic cycle and equity rally - and at the same time, the unexceptional European situation has led to the performance and valuation gap between US and European equities to widen massively and hit new records – with the difference in Price / Earnings ratio between the S&P 500 and the MSCI Europe reached a staggering 11 points; except for the “tech bubble” these are by a very wide margin unchartered territories. And yes, this is also true when adjusting for sector differences between US and European indices.

A broadly shared over pessimistic sentiment on European assets means that in fact some great quality assets can be bought at a discount compared to their American peers. Indeed, for an equivalent level of expected sales growth the median Price / Earnings is as much as 3 to 5 points lower in Europe –

examples such as Safran and General Electric , which both enjoy equivalently high long term EPS growth expectations but display a 20% valuation discount;

likewise for pharmaceuticals giants Novo Nordisk and Eli Lily;

or in consumer staples, with Reckitt Benckiser ’s 2025 PE at 14x standing 40% lower than Colgate-Palmolive ’s 2025 PE of 24x (and a similar gap can be seen on EV / EBITDA or various other valuation metrics).

And such variances go beyond idiosyncratic differences. When looking at sectors such as utilities where Return On Equity are north of 10% on both side of the Atlantic, valuation metrics be it P/E or Price/Book terms are also miles away – albeit not as much as 3,800 miles apart!

The flip side of the valuation coin is also important. The US cycle is exceptional indeed, but so are US equity markets valuations. The election of Mr. Trump is expected to reload US exceptionalism for some quarters, but can high valuations last for eternity? Given the space US equities have taken in stock ownership (with foreign holdings of US equities reaching all-time highs at more than 55% of allocation) and in indices (with the S&P 500 market capitalisation equalling 70% of the global market cap), Europe can offer a great diversifier for investors; even more so given the risk to see the return of bond vigilantes, who by calling the end of US exceptionalism could be the catalysts for a great regional rotation.

Beyond the valuation case, there could well be some positive spillovers for the EU coming from the Trump 2.0 policies.

Indeed, they are readily associated with a weaker EUR, lower oil prices and lower Euro bond yields. All of which would have an aggregate positive impact on European companies’ earnings. With the rule of thumb being that a 10% depreciation in the EUR contributes to an equivalent growth in EPS; that oil prices falling by 10% does help on both the growth and the inflation side by a similar order of magnitude of 0.4% (plus and minus respectively); and that lower bond yields serve both in lowering companies’ cost of capital and alleviating valuation pressure for the price of carefully selected equities.

Besides the unpredictability of the president-elect along with his self-centred policies would force Europe to accelerate on the reform front. European institutions have proved that they can be malleable at times of existential crisis.

And the old continent has proven it capacity to innovate and lead in green and digital transformation with 18 countries of the Top 20 Green Future index being found in Europe; the €30bn to €90bn extra spending in defence and aerospace is poised to benefit the world leading companies in the sector – and 6 of the 12 largest are based in Europe; and increased spending in research and development to improve strategic autonomy in healthcare or single market integration will further support economic growth.

It could also finally trigger more stimulus measures from China which would also benefit European corporate issuers.

As such while we're not expecting a burst in earnings growth given what is happening – or rather not happening – on the continent but several factors could in fact play in favour of European equities where so many global leaders can be found at a very reasonable price.

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