Olivier Baduel, Head of European Equity Management at Ofi Invest Asset Management, analyses the trends and catalysts driving European equity markets, which are currently approaching record highs.
What is your analysis of the economic situation in the eurozone?
The European economy is subject to two opposing trends. On the one hand, the tariffs imposed by the United States are expected to cost European countries between 0.3 and 0.4 percentage points of GDP. On the other hand, however, the implementation of massive stimulus packages in Germany should offset these negative impacts.
Indeed, Friedrich Merz's election as German Chancellor has led to the launch of a «double bazooka» budget in the country, focusing both on infrastructure funding and an increase in the defence budget. The amounts involved – €50 billion per year over ten years for the infrastructure plan and nearly €450 billion for defence – represent more than the combined investments in the US Inflation Reduction Act (IRA) and Chips Act(1) or the EU Recovery & Resilience Fund(2) in Europe. This plan is expected to boost the German economy by 0.3 to 0.4 percentage points of growth, which, given the country's weight in European GDP, represents an additional 0.1 to 0.15 percentage points of growth for the eurozone. In addition, the increase in military spending could generate an additional 1.15 percentage points of GDP over several years.
Another encouraging factor is that, at 2.2% year-on-year, inflation in the eurozone has practically returned to the target set by the European Central Bank (ECB). According to our economists' forecasts, it will average 2.1% in 2025 and should continue to fall to 1.6% in 2026. This should promote the establishment of a sustainably favourable monetary environment throughout the eurozone.
From this perspective, even though the ECB is slightly less active than other central banks, it is also participating in a global trend towards large-scale monetary easing: over the past twelve months, no fewer than 168 key interest rate cuts have been recorded worldwide. This is good news for the economy and the markets, for two reasons. When rates fall, businesses and households can borrow more cheaply, which stimulates activity. And when returns on risk-free assets decline in line with falling short-term rates, investors tend to seek out riskier assets, which offer higher returns for the risk involved in this context.
What impact is this economic situation having on the European equity market?
All these factors enabled European markets to set records during the last few weeks and make up for their valuation discount.
Three years ago, European equities were very cheaply valued, trading at 10 times earnings. Two years ago, we were close to 11 times. Now, valuation multiples have returned to slightly above their long-term median. In fact, it is the rise in valuation multiples that explains most of the 20% increase in eurozone equities since the beginning of the year. Earnings growth accounts for only 2.1% of the increase, impacted by the depreciation of the dollar, which weighed on earnings, while dividends contributed 3.5%. The remainder of the increase – nearly 151% – is attributable to the revaluation of multiples.
In detail, certain market specificities are worth highlighting. The main one relates to the extreme concentration of index performance in a few sectors. While much attention has been focused on the US technology sector, with its «Magnificent Seven» " (4), another phenomenon has been particularly striking, this time in Europe: eurozone bank shares have risen by nearly 60% since the beginning of the year. Over the past three years, European banks have outperformed large US technology stocks by more than 50%.
Despite this massive outperformance over the past four years, multiples of valuation still seems reasonable to us, both in absolute terms and relative to their history.
What is your position on the euro equity market today?
In our view, the catch-up in the euro equity market reduces the strength of the signal. buyer for this asset class and encourages us to remain close to neutrality on the weighting of this market. Especially since earnings growth remains modest for the current financial year. Nevertheless, we could talk about «positive neutrality» because we remain broadly favourable to the point of considering a return to the asset class in the event of a market downturn.
Towards a comeback for European mid-caps?
European mid-cap stocks significantly underperformed in recent years and are now trading at a significant discount in terms of valuation. This has not always been the case. When this segment began to develop, it was trading at a discount due to its lower liquidity. However, the valuation of mid-cap stocks quickly benefited from certain advantages linked to their size: a good capacity for innovation, for gaining market share market and therefore higher potential growth in the medium term. Their premium The valuation linked to this growth potential has tended to be all the more significant during the sharp fall in interest rates in the 2010s.
But the rise in interest rates has not been favourable to them, with conditions tightening. access to credit and the increase in its cost, which has weighed on their multiple valuation. Despite the monetary easing of recent months, we we are still following this pattern today.
Finally, mid-caps are, by nature, more domestic in focus. An acceleration in growth in the eurozone could serve as a catalyst for their revaluation.
(1) The US CHIPS Act, officially named the «Creating Helpful Incentives to Produce Semiconductors for America Act», is a law adopted in August 2022 to strengthen domestic semiconductor production in the United States.
2) The EU Recovery and Resilience Fund, officially called the Recovery and Resilience Facility (RRF), is the central pillar of the plan. NextGenerationEU European recovery plan, established in response to the crisis caused by the Covid-19 pandemic
(3) The price-earnings ratio is a stock market analysis indicator, corresponding to market capitalisation divided by net profit., expected over the next 12 months.
(4) The «Magnificent Seven» are the GAFAM companies - Alphabet (Google), Amazon, Meta (Facebook), Apple and Microsoft - to which Nvidia and Tesla are also included.