Europe: Finding the Bright Spots
Look behind the clouds for promising investment opportunities.
Despite macro-economic uncertainty about Europe, investors should consider maintaining a strategic equity allocation to the region as it offers some unique diversification benefits.
The case against Europe
Economic data for the first three quarters of 2019 suggest that Germany might be on the edge of recession as a result of ongoing U.S./China trade issues and Brexit angst. Meanwhile, political turmoil and a mountain of debt pose a serious threat to Italy’s economic well-being. Spain faces a Catalonia independence movement, and in France, President Macron’s green tax has mobilized yellow vest protesters. Given the economic and political challenges, as well as trailing equity markets, it’s understandable that investors may be cautious about broad market exposure to the region.
The case for Europe
Yet, Europe has some green shoots. The European Central Bank (ECB), the monetary policy maker for the eurozone,1 recently launched another aggressive quantitative easing program. Meanwhile, the eurozone’s annualized wage growth is already heading in the right direction, from 2.3% to 2.7% in the last four quarters. Unemployment in the eurozone has come down in recent months from its 2008 highs to around 7.5%.2
Although the U.S. S&P 500 Index has outperformed the MSCI Europe Index seven of the last 10 years, the MSCI Europe Index has bested the S&P 500 Index in 10 individual years of the last 2 decades.3 Moreover, from 2000, when the U.S. tech bubble burst, to 2008, the MSCI Europe Index led U.S. markets.
If that’s not a sufficiently compelling investment case, consider these additional facts:
- Many of the largest companies in Europe generate less than a third of their revenue from the eurozone, so macro considerations at home may not affect company performance.
- Developed European equities are trading at a wide discount to U.S. equities on a forward P/E basis at 14.05X versus 17.26X, respectively, while the MSCI Europe Index has a dividend yield of 3.79% versus that of the S&P 500 at 1.9%.4
- Some European companies are global leaders and innovators in industries such as luxury goods and renewables.
- Europe has more companies with higher ratings for sustainability and ESG management than any other region,5 ratings that are linked to lower enterprise risk and better corporate performance over time.6
Developed Europe represents about 15% of the MSCI ACWI Index but is also the third biggest contributor to global domestic product (GDP), meaning it should not be ignored.
The 443 companies in the MSCI Europe Index sourced nearly 70% of their cumulative revenue from outside developed Europe in the last year.
Against an uncertain macro outlook, stock selection matters more
Europe makes the case for active investment management. Buying a broad geographical market index can expose an investor to the range of challenges hitting the region. Contrast that with a fundamental, bottom-up approach which can pinpoint investment opportunities to help shield a portfolio from macro storm clouds.
For example, an active manager can find those European companies that source much of their revenue from Asia and North America. Specifically, a benchmark-agnostic stock selection process can find attractive relative value opportunities and focus on them, without being restricted by sector or country weightings.
Clouds on the European macro horizon may come and go, but a highly active, benchmark-agnostic manager has the potential to find compelling bright spots in Europe’s equity markets.
2. Source: Official website of the European Union, https://ec.europa.eu
3. Source: Bloomberg. The MSCI Europe Index outperformed the S&P 500 Index in 2000, 2002, 2003, 2004, 2005, 2006, 2007, 2009, 2012, and 2017.
4. Sources: Thornburg and Bloomberg, MSCI Europe Index vs. S&P 500 Index. As of October 31, 2019
5. Source: Morningstar Sustainability Atlas, October 2019, Index scores range from 48.61 in Belgium to 60.29 in Finland for the 15 countries in the MSCI Europe Index vs. 40.55 in China and 45.85 in the U.S.
6. Sources: Morningstar, "Sustainable Investing Research Suggests No Performance Penalty,” November 10, 2016. Two older meta-studies show that ESG investing delivers higher returns on average: “From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance,” published by Smith School of Enterprise and the Environment at the University of Oxford, March 5, 2015. “ESG and Corporate Financial Performance: Mapping the global landscape,” published by the University of Hamburg, December 2015.