With the S&P 500 about 30% above its March lows, the Stoxx 600 index has lagged behind with a 21% bounce, despite having fallen more than the U.S. in the global selloff sparked by the coronavirus pandemic.
The reason? For starters, there’s the market’s makeup: Europe has a large presence of cyclical sectors, such as banks and energy, which have underperformed during this crisis. On top of that, the region has led the recent wave of dividend cuts by major companies. Investors have also been disappointed by the scale of fiscal and monetary support measures as Europe faces its deepest recession in living memory.
The rebound in stocks around the world has been driven by companies with reliable earnings growth and solid balance sheets as investors seek safe havens amid slowdown fears. The U.S. technology sector has emerged as one of the biggest beneficiaries of this trend, with the five biggest names such as Facebook Inc. and Amazon.com Inc. constituting 18% of the S&P 500’s market capitalization, more than double the value of the U.K. FTSE 100 Index and five times larger than Germany’s DAX, according to Sanford C. Bernstein data.
“In order for Europe to take the lead regionally, we really need a rotation into more cyclical and value areas of the market,” Nathan Thooft, Manulife Investment Management’s head of global asset allocation, said by email. “I am not convinced we have the necessary level of economic clarity for that to happen.”
And although Thooft, who is overweight U.S. equities, sees “decent value” in European stocks in the longer term, he says the market lacks a catalyst. Earnings in the Stoxx 600 companies are projected to slump 23% in 2020, compared with a 19% contraction in the S&P 500, Bloomberg data show. The euro-area economy could shrink as much as 12% this year and fail to return to its pre-coronavirus size until the end of 2022, the European Central Bank says.
While the ECB and major European economies, including Germany, the U.K. and Italy, have been stepping up support measures to help consumers and companies weather the slump, investors feel that the U.S. has acted swifter and pumped more money into the system.
“The fiscal response in the U.S. has been so big relative to everybody, that’s a big piece of how the recovery is going to look in terms of who comes out stronger on the back of this,” Jack Janasiewicz, portfolio strategist and manager at Natixis Investment Managers, said by phone. “And that’s why you’ll continue to see the U.S. outperform.”
Peter Oppenheimer, chief global equity strategist at Goldman Sachs Group Inc., agrees with this sentiment, but at the same time said on Bloomberg TV that once market players get more confident about “a genuinely strong” recovery in activity, European stocks can outperform.
GRANOLAS
The Goldman team this week released a list of European companies, dubbed GRANOLAS and which include GlaxoSmithKline Plc, Roche Holding AG and ASML Holding NV, that can beat the market during the next cycle thanks to their strong balance sheets, stable growth and good dividend yields. The strategists, including Guillaume Jaisson, point out that while 20 years ago Europe’s ten biggest companies were telecoms and oil firms, these along with banks are now absent from the top stocks by market value and the tech sector has grown to exceed energy, rising closer in size to the banking subgroup.
Still, the European stock market has been held back by last month’s historic slump in the oil price, which also weighed on mining shares. And the region’s banks continue to be hurt by low interest rates and increased concerns about corporate defaults.
European firms have been much swifter in slashing or suspending dividends than their U.S. counterparts, with at least 189 companies in Europe’s Stoxx 600 benchmark having canceled or postponed payouts. Part of the reason is that the ECB has recommended that lenders delay dividends in response to unprecedented support measures while certain governments, like France, have made it a clause in receiving state aid.
“Most investors entering Europe are chasing dividends,” Roland Kaloyan, head of European equity strategy at Societe Generale SA, said by phone. “And now, Europe is losing its key appeal because of all the dividend cuts over the last several weeks. Yes, it’s great news for the bond holders, but not for the shareholders.”
SocGen is overweight credit and underweight stocks in the region.
Investor flows also show little love toward European stocks, even though the Stoxx 600 gauge just had its biggest monthly bounce since 2015. The region’s stock funds had their largest outflows in six weeks of $2.7 billion in the week through April 29, according to Bank of America Corp. data, adding to a year-to-date toll of about $24 billion.
“The U.S. will likely lead the rest of the world until we start to see expectations and signs that global growth differentials begin to narrow in favor of the rest of the world,” Manulife’s Thooft said.