A former colleague of mine from the USA used to say that Europe is a great place to visit, a great place to live but a terrible place to invest.
Whether that’s true or not over the longer term, the outlook for 2023 is better for European equities than their US counterparts in my view. The 2022 Q4 reporting season for companies in Europe is well underway and is almost finished for S&P 500 companies in the US. The US did not suffer the huge rise in energy bills seen in Europe last year but despite that companies there underperformed their European counterparts in almost every respect. In particular, the squeeze on profit margins was severe for S&P 500 companies, much less for those in Europe and the UK. Europe’s results also beat expectations, whereas those in the US were disappointing.
The big news in Europe is the decline in energy prices, from the extraordinary levels seen last autumn. Those high energy prices pushed inflation to double digit levels in Europe and the UK and destroyed consumer confidence. Nervous consumers increased their savings, despite having a big pile of unspent savings from the covid period – the so called ‘covid piggy bank’. The contrast with the US was acute with more confident consumers drawing down on their piggy banks.
There’s a plausible scenario whereby Europe’s consumers regain their confidence and begin to spend – corporates will benefit from this increased demand and lower energy costs.
Energy prices have fallen, and European equities have outperformed so some may ask whether all this good news is already in the price. I don’t think so. Surveys of investor confidence in Europe remain gloomy with the recently released Sentix index coming in weaker than expected and well below the pre covid average. There is plenty of potential upside here and economic forecasters have only just begun to revise their forecasts for growth up and analysts are likely to respond with higher earnings estimates.
Another factor is Europe’s greater exposure to China. This placed Europe at a disadvantage (relative to the US) during China’s disastrous zero covid policy but is now a plus as China’s economy reopens.
Of course, it’s not all good news and recent inflation numbers have been disappointing, and the European Central Bank is likely to respond with higher interest rates. But inflationary pressures have risen in the US too and the economy there looks closer to recession as credit standards tighten and consumer arrears (delinquencies) rise, albeit from low levels.
In the next few we’ll likely see improved economic forecasts for Europe and notably in the UK where the Bank of England and Office for Budget Responsibility are likely to raise their growth forecasts and reduce inflation forecasts. There will no doubt be warnings of problems in the medium term but the bleak pessimism that characterised the last set of projections should be replaced with a greater degree of optimism, and this could well boost equities.
