Don’t Throw Dirt on European Stocks Yet

Every day, headlines tell us sentiment is too hot and this young bull market is nothing but a narrow, AI-fueled sugar high. Indeed, we don’t deny the hot performance of the so-called Magnificent Seven US Tech and Tech-like stocks or the enthusiasm toward them. Yet not only is bubble talk self-deflating and itself a sign of skepticism, but the rally is also a lot broader than it gets credit for. And encouragingly, the participants in this broadness are still quite unloved—if they are even noticed. Case in point: European stocks.

Lately, chatter abounds about Europe’s competitiveness, or rather lack thereof—particularly in the Tech space. Where the US has the Mag Seven and a legendary startup culture, we are told Europe has only stodgy old software and hardware companies with minimal AI exposure. Analysts explore the reasons for this, including local regulations, the state’s large role in directing investment, high energy costs, bureaucratic barriers to business creation, labor laws and more. Without structural reforms to encourage more risk taking and subsidies to juice the private sector, they claim Europe will lag indefinitely. Not just on the Tech front, but economically.

Setting the Magnificent Seven myth aside, many of these issues are, to various degrees, true. But from stocks’ perspective, there is a world of difference between interesting observations about the structural backdrop and cyclical economic and stock market drivers. Structural factors do matter, but they are widely known and get priced in. We think that is the case with Europe, whose latent issues have been part of the conversation since the emotional high of the euro’s creation wore off about 15 years ago. There isn’t much, if any surprise power left in the bloc’s regulatory headwinds, cost of doing business or relatively lower private investment.

But this all really underrates cyclical drivers, too. Yes, thus far in the bull market, Tech has led. And that does favor America overall, given the US’s larger Tech sector. But everything has its day in the sun and the rain, and we can see a scenario in which value leads later this year. That isn’t assured to deliver European leadership, but it would likely be a tailwind, given the bloc’s relatively big dose of offensive value-oriented companies like Industrials, Materials and Financials.

Also? European stocks—including European Tech—aren’t exactly floundering. We have seen few talk about it, but the MSCI EMU Information Technology sector is trading at comparable valuations to S&P 500 Tech. Eurozone Tech’s trailing P/E ratio is 30.04, a stone’s throw behind US Tech’s 33.04 trailing P/E.^[i] As for forward P/Es, eurozone Tech’s 30.6 exceeds S&P 500 Tech’s 28.19, showing the premium on future earnings is even higher across the pond.^[ii] And how did we get here? Since the global bull market began on October 12, 2022, eurozone Tech has outperformed US Tech, 100.4% to 84.7%.^[iii] It is also ahead of the US Interactive Media and Services industry, home to some of the Magnificent Seven, which is up 90.1% since the low.^[iv] Yet everyone thinks European Tech is in the dumps and the Mag Seven have no peers. Seems wrong to us.

It isn’t just eurozone Tech that is doing well—eurozone stocks broadly are at all-time highs and rising on a price basis when measured in euros and on a total return basis in USD. Some eurozone economies may be in a soft patch, but their stocks have dealt with it and moved on and up. Not because they are whistling past the graveyard, but because they are doing what they always do and pricing in the likely reality over the next 3 – 30 months—after having priced the mounting probability of economic trouble during 2022’s downturn. Said differently, eurozone markets aren’t complacent, just anticipatory—on the downside and now on the upside, demonstrating their traditional forward-looking prowess.

So it seems to us stocks are sending a very strong signal that the eurozone’s structural issues, real as they may be, aren’t a big, unseen drag on earnings over the foreseeable future. Rather, the attention on those issues helps keep expectations low, creating a bigger gap between sentiment and reality—a bullish one.