The summer has gotten off to a reasonable start with global equities moving higher in recent weeks. The prevailing market narrative – decelerating inflation that is paving the way for central banks to cut interest rates – was reinforced by June’s weaker-than-expected U.S. inflation data. Moreover, U.S. Federal Reserve Chairman Jerome Powell’s recent commentary suggested the Fed is growing more comfortable with the inflation backdrop and is beginning to pay more attention to slowing employment trends. While we tend to focus on issues in North America, we also closely monitor developments overseas. Below, we take a closer look at Europe, discussing a few developments and providing a brief investment update.
A few notable elections took place across Europe recently. In France, a left-wing alliance unexpectedly came out on top in the country’s parliamentary elections. The lack of a clear majority makes it unlikely that President Emmanuel Macron can pass any meaningful legislation to address the country’s budget challenges. In the U.K., a landslide victory for the Labour party was largely expected and viewed positively, as the incoming government has advocated for “stability” in politics and policy, still somewhat scarred by the government-induced bond market crisis from a few years ago.
Economic activity in the region has generally improved throughout the first half of the year, with growth seen in both services and manufacturing sectors. However, the latter remains relatively weak, weighed down by important industries like automotive and luxury goods, which have been grappling with weak demand from China, a key export market for Europe. Meanwhile, inflation has continued to decline, though there have been some upside surprises here and there. Nevertheless, the European Central Bank (ECB) initiated its first interest rate cut over a month ago. As with other central banks, it is managing expectations carefully, though another rate cut is anticipated this fall.
As with other geographies, European equities have posted respectable gains in the first half of the year. While the largest companies in the technology and healthcare sectors have driven some of these gains, other sectors have also performed well. It’s worth noting the region’s equity market looks different from a sector perspective than North American markets and is arguably more diverse. No sector represents more than 20% of the market, with Financials, Industrials, Health Care, and Consumer sectors comprising nearly 70%. From a valuation perspective, the European stock market’s forward Price to Earnings ratio, which reflects the current price divided by the earnings expected from the companies within the index over the next twelve months, is just under 14 times. This aligns closely to its historical average, suggesting investors can expect reasonable returns out of the asset class over the long-term.
The risks we frequently discuss in relation to U.S. and Canadian equities also apply to Europe. In our view, the range of outcomes remains wider than normal given the potential impact of higher interest rates on future economic and earnings growth. A shift in policy from the ECB, via lower rates, may eventually provide some relief, but the effects will unfold gradually, given the time it takes, typically a year or more, for interest rate changes to work their way through the economy. Fortunately, current valuation levels in the European equity market are not necessarily rich, suggesting any future periods of weakness are unlikely to be severe.
Should you have any questions, feel free to reach out.
Enjoy the weekend,
Mike