Current Challenges for European Stocks
The driving forces behind Europe’s stock market gains over the past two years are losing momentum. This shift leaves European equities vulnerable, especially amid concerns about slowing growth and tensions with China.
Luxury and Automotive Sectors Hit Hard
In the past six months, the luxury sector, led by LVMH Moët Hennessy Louis Vuitton SE, and automotive firms have faced significant declines. Recently, healthcare giants like Novo Nordisk A/S and technology leaders such as ASML Holding NV have also seen their stocks fall from recent highs. With no clear new leaders emerging, European stocks are left exposed.
Investor Trends
Investors have pulled billions from Europe-focused funds and ETFs this year. This contrasts sharply with the influx of investments into U.S. and international equity funds. One major issue is that Europe’s leading companies have not matched the performance of America’s top tech firms, known as the Magnificent Seven.
“Leadership is changing in the European market,” says Ariane Hayate, a fund manager at Edmond de Rothschild Asset Management. “Smaller and more defensive sectors are now leading.”
Economic Sensitivity and Trade Risks
Cyclical Nature of European Market
Europe’s market is inherently more cyclical compared to the U.S. Approximately two-thirds of the benchmark Stoxx 600 index consists of economically-sensitive sectors. As a result, the index is highly correlated with these sectors. However, this support is now threatened by slowing growth and escalating trade risks with China.
Impact of Global Trade Risks
Many European companies derive a significant portion of their revenue from the U.S. and China. Barclays Plc strategist Ajay Rajadhyaksha notes that if global trade tensions escalate, these companies might experience a decrease in their stock values.
Growth and Trade Concerns
Dependence on Chinese Demand
European firms rely more on Chinese demand compared to their U.S. counterparts. According to Goldman Sachs Group Inc., about 8% of European revenues come from China, compared to just 2% for S&P 500 companies.
In response to competition, Europe is considering additional tariffs on Chinese-made electric vehicles. Furthermore, China’s economic troubles are contributing to low oil prices, impacting European energy giants like BP Plc, Shell Plc, and TotalEnergies SE. London’s mining stocks are also suffering due to falling iron ore and copper prices.
Contrasting U.S. Performance
In contrast, U.S. Big Tech companies have significantly driven returns, with six of them featuring prominently in the top ten of the benchmark index. These companies have generated over 50% of the returns.
In Europe, the healthcare sector has been a major contributor to the Stoxx 600 index’s performance this year. Including consumer staples firm Unilever Plc, these five companies account for over 30% of the index’s performance. However, this defensive bias may not provide the same growth as cyclicals like luxury firms.
Future Outlook and Sector Rotation
Earnings and Profit Estimates
Earnings estimates for 2025 remain relatively stable. However, Barclays’ Rajadhyaksha suggests that data surprises are more likely to have a negative impact. A Citigroup Inc. gauge of earnings revisions has shown negative trends for much of the summer.
Emerging Opportunities
With traditional leaders fading, investors are looking for new opportunities. Gilles Guibout, a portfolio manager at Axa Investment Managers, sees potential in banks and utilities. “Rising dividends could help boost valuations, and banks and utilities are key dividend payers,” he says.
European banks have performed well, rising by 18% this year. Guibout notes that there is room for further gains due to low valuations. Interest in the sector has increased, especially since UniCredit SpA’s CEO Andrea Orcel mentioned a potential full takeover of Commerzbank AG.
For utilities, lower interest rates provide immediate relief. Guibout adds that these stocks have started to outperform, with prospects for rising dividends, earnings, and multiple expansions.
Looking Ahead
Fund managers are eyeing sectors that could lead the market if a recession is avoided. “If we’re heading towards a soft landing, it makes sense to bet on a broader rally and on laggards like small and mid-caps,” says Amelie Derambure, a senior multi-asset portfolio manager at Amundi in Paris. “We’re monitoring growth momentum indicators closely. Lagging sectors could drive the market if economic growth rebounds.”
In summary, Europe’s stock market is undergoing significant shifts, with traditional leaders losing their influence. Investors are now seeking new opportunities in more defensive and cyclical sectors, with hopes that these areas can drive future growth.
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