Euro 2021: A Recovery Round?

Global equities have experienced a robust recovery since reaching the pandemic-induced lows in March of 2020. The U.S. has led all other major markets, in local currency terms, with the S&P 500 Index rising over 56% for the 12 months ending March 31, 2021.ⁱ The well-publicized performance of the so-called “FAANGM plus” stocks were the early leaders and up until recently drove the overall return of the index. Lately, however, we have seen a resurgence in more cyclical or “value” stocks, and they have overtaken higher growth-oriented names (see Bloomberg Value vs. Growth chart)

Europe tends to be a more cyclical economy than the U.S. and could continue to benefit from the rotation to “value” we have been witnessing.

A few months ago, we moved from underweight to a more neutral weight in Canada to try to capture some of the cyclical trade. We’re now looking across the pond as the Euro area also tends to perform well in the early stages of an economic recovery.

The U.S. has led all other markets as its monetary and fiscal policy responses to the pandemic were epic. Early on, the Federal Reserve quickly lowered interest rates and reinstated the bond buying program, or quantitative easing, that it used during the Global Financial Crisis in 2008. Anticipation of fiscal stimulus late last year and the approval of vaccines to fight COVID-19 further fueled investor sentiment.

With massive fiscal stimulus programs now in place and the best pace of vaccination rollouts, the U.S. market has continued to perform well. This has pushed valuations to levels that may be vulnerable to any disappointment. Couple this with early improvement in macro and micro economic data in Europe and maybe it is time to look outside of the U.S. for the next phase of the global market recovery.

Macro Environment

The macro environment seems to be improving in the Eurozone. Key data we are following include:

• Vaccine Rollout
  Vaccination rates in the UK have been impressive and they are starting to improve in other European countries.

• Fiscal Stimulus
  The U.S. and Canada led the world in terms providing fiscal stimulus. It had been difficult to coordinate government support among the many European countries, but as of May 28 all national parliaments of the EU had passed a pandemic stimulus plan.ⁱⁱ
• Leading Economic Indicators
  These indicators in Europe are rising and this tends to be good for stock prices and cyclical sectors in particular. The OECD Europe Composite Leading Indicator Index plunged to 94 in April of last year and hit 100.3 in May of this year.ⁱⁱⁱ A level of 100 or more indicates the economy is growing.
• Investor Sentiment
  Investor sentiment is low but starting to rise. The Sentix Index is based on a survey of over 5,000 investors and measures investor sentiment. A reading below zero indicates pessimism while a reading above indicates confidence. The index had essentially been in negative territory since 2019 reflecting the uncertainty around Brexit and the pandemic. In March it was hovering around +5. The high over the last five years reached +34 in 2017, so it seems there is some room to go.^iv

Micro Environment

In addition to the improving macro environment, micro level data such as earnings growth and valuations are also improving.

• Earnings Growth
  Earnings growth is accelerating and actually looking better than in the U.S. Momentum indicators such as upward revisions and positive surprises are evident.

• Valuations
  Valuations in the U.S. have risen to high levels and while they are somewhat supported by high growth and low interest rates, we think they are vulnerable to any disappointment. By contrast, valuations in Europe are relatively more attractive both to U.S. and historic levels. Valuation is not usually a good timing indicator, but it is pretty good at portending future returns and presently it looks like Europe could provide returns in excess of the U.S. during the next stage of the market cycle.

• Banking System
  One risk that had overshadowed the Eurozone was its capital constraints, brought on in part by a few trading and accounting scandals over recent years. It seems banks are now in better shape and the ECB is open to letting banks close branches to improve profitability and even consolidate^v. So this headwind seems to be losing some steam, opening the way to increased lending and capital investment.

Going Back to Europe

The Euro area is starting to look more attractive to us, especially relative to the U.S., which has performed well since the lows of last year. The macro and micro data are looking better and given its more cyclical make up, Europe could outperform other areas of the global equity market over the short-to-medium term. It is not without risks, however, and the U.S. could continue to deliver strong returns. So, we are going overweight on the Eurozone from being underweight for the past few years and reducing our exposure to the U.S. somewhat to manage the valuation risk we see there. If we get further positive confirmation of the data points mentioned above we will get more committed to the Euro area and increase our exposure.