By Ksenia Galouchko, Bloomberg Markets Live reporter
European equities are broadly falling behind this year’s powerful rally in the US market, but a deeper dive shows that the region’s blue-chip stocks can help investors outperform the S&P 500.
With mounting recession fears and still hawkish central banks, some European stocks may be better positioned than others for a bumpy ride in the second half of the year. Among investor favorites are defensives, as well as companies with strong fundamentals.
The Euro Stoxx 50 gauge of large caps has climbed 14.8% this year, beating both the Stoxx 600 and the S&P 500. While sector gains in the broader European gauge have been led by travel and retail, corporate heavyweights like LVMH, ASML and SAP have contributed the most to its advance, signaling favor for safer bets.
Betting on quality and high-growth companies with strong pricing power in Europe has helped Comgest Growth Europe gain a 17% total return so far in 2023 including reinvested dividends, according to Alistair Wittet, one of the fund’s managers. The fund, whose top holdings include ASML, Novo Nordisk and LVMH, has beaten 97% of peers this year, according to data compiled by Bloomberg.
Luxury companies like LVMH, L’Oreal and Ferrari are among the top gainers in Europe this year. While Chinese demand — a key driver — has been uneven, Wittet says their high margins, strong pricing power and wealthy consumers’ resilience to downturns will allow them to maintain market leadership. The stocks are also less rate-sensitive, given low debt and high free cash flow levels.
A factor in Europe’s favor is that gains are distributed more broadly than in the US, making the broader market less vulnerable to selloffs in a particular sector or group. While 15 of the biggest companies have driven 86% of the returns in the US stock market, the same number of stocks in Europe have accounted for just 39%, according to Goldman Sachs strategists.
The more diverse sectoral exposure protects the European stock market from a sudden selloff in case tech shares fall out of favor, says Lode Devlaminck, managing director for equities at DuPont Capital. He has a preference for European equities over the US due to cheaper valuations and lower market expectations.
The question investors are asking is whether the gains in bigger companies can expand to the rest of the market or if large caps will succumb to recession fears that have been pressuring smaller peers. According to Goldman strategists, when European stocks rally with narrow leadership, the subsequent 12-month returns for the aggregate index are positive in more than two-thirds of the instances.
For the broader European market, headwinds remain. Weakening activity data and a technical recession in Germany have fueled an unwinding of bullish positions in European stocks and there may be more redemptions to come, says Barclays strategist Emmanuel Cau. The bank notes that Europe was the only major equity region to see fund outflows in June.
“If the second half of the year proves to me more challenging than the first half of the year because inflation stays stubbornly high or because interest rates continue to rise, or because the economy weakens, we think these businesses will prove resilient in that environment,” Comgest’s Wittet said, highlighting quality stocks.
