Yes, we believe that the euro area’s economy bottomed either in fourth quarter 2023 or first quarter 2024. The abatement of headwinds that saw GDP flatline during 2023 should allow for some expansion in 2024. Nonetheless, the growth impulse is likely to remain muted and growth should underperform the United States. Therefore, despite comparatively subdued relative valuations, we believe euro area equities should be held in line with benchmark weights.
The euro area has only had one positive quarter of GDP growth since fourth quarter 2022, and that was a paltry 0.1%. Of course, the region has faced economic challenges in that time. For a start, it was still dealing with the aftereffects of the spike in gas prices resulting from the war in Ukraine. This was compounded by the interest rate–hiking cycle. The impact of higher rates and tighter lending standards was more severe than in the United States, due to generally shorter fixed-rate terms on mortgages and a higher proportion of bank lending in the corporate sector. Significantly, fiscal policy also retrenched more rapidly in the euro area than in the United States.
Indicators of economic activity have risen sufficiently to suggest we are past the trough in growth. Indeed, the composite Purchasing Managers Index for the euro area rose to 50.3 in March, indicating the monetary union’s first monthly economic expansion since May 2023. Real wage growth is now also turning positive as the rate of inflation declines, a supportive factor for consumption. Net bank lending has also now turned positive, albeit modestly so, and should be further stimulated if rate cuts are delivered later this year, as expected. The important export sector also seems placed to benefit from the improvement in world trade volumes that are starting to emerge, including in the bellwether markets of Korea and Taiwan.
Still, it would seem premature to get carried away with the growth prospects for this year. For one, fiscal policy looks set to be a drag on growth this year. Indeed, by some estimates, the fiscal drag in 2024 may be larger than that in 2023. Additionally, even though credit growth is now positive and should improve, it has some way to go before reaching more ‘normal’ levels that would be associated with growth somewhere near potential. Furthermore, while the cyclical backdrop should gradually improve, certain secular headwinds remain. Perhaps the most prominent example is the growing share of global motor vehicle production enjoyed by China, at the expense of Germany in particular.
The momentum of euro area equities is sufficiently oversold on a relative basis; therefore, it is not unreasonable to expect a short-term bounce. Relative valuations also look a little depressed versus where their historical relationship to profitability suggest they should be. Nonetheless, euro area equity fundamentals are in a downtrend when compared to their global counterparts. Seven of 11 sectors are seeing a deteriorating trend in relative return-on-equity, while six of 11 sectors are seeing relative earnings expectations moving down. There is also considerable event risk associated with the US election in the form of the potential imposition of trade tariffs. We await further evidence that the macro environment is turning more favourable for the euro area and that the relative descent in equity fundamentals has ended, which then may lead to a period of outperformance. We, therefore, recommend continuing to hold euro area equities in line with benchmark weights.
Thomas O’Mahony, Senior Investment Director, Capital Markets Research