European Shares Have Been On Fire. There’s A Chance That Could Continue

Main Thesis/Background

The purpose of this article is to discuss the broader European equity market with a focus on its recent performance and my outlook going forward into the second half of 2024. This is a supplementary article to my recent review where I discussed my preference for large-cap US stocks. This still rings true, but readers are likely wanting to stay diversified as domestic indices hit all-time highs. So while I remain a US bull, that doesn’t mean there isn’t value to be had elsewhere.

With this comes a look at European shares. This is because I have transited out of emerging market exposure (both bonds and stocks) but I continue to want to hold something outside of America. This being the case, I like to manage my risk as well as possible, and this leads me to developed markets overseas (rather than more volatile areas). For me, this suggests Europe (and Canada – but that is for another review) are smart places to park some cash. In this article, I will cover why I look favorably upon this region and how investors could profit from this outlook in the months ahead.

**I own the SPDR Euro Stoxx 50 ETF (FEZ) and the Schwab International Equity ETF (SCHF). I would recommend both for non-US developed market (and European) exposure, but there are a plethora of options out there.

Valuation Discount Across The Pond

To begin, I want to manage expectations here. While I continue to believe equity prices have a path to go higher, we have to recognize where we are in terms of relative valuations. Stocks are not cheap in absolute levels – with US markets being an obvious indication of that (just a few percentage points away from all-time highs). Similarly, European shares (and other developed markets) have been on bull runs as well:

As you can see, FEZ is outpacing the S&P 500 and SCHF (which holds a large amount of Japanese and British exposure). So I will emphasize this is not a “cheap” play, even if other metrics suggest it is. These equities have been bid up nicely in the short-term, and that should limit the expectations for gains ahead, even if one is a bull (as I am).

That said, it is worth noting that despite this out-performance by European shares, they do have the advantage of a relative discount compared to the US (as measured by the S&P 500). European stocks are trading below their US counterparts in terms of P/E levels, and are also below their own long-term P/E average. This could entice value-oriented investors to keep on buying:

The conclusion I have here is, European stocks are not really expensive in relative terms to the US and to their own history. While I hesitate to say they are cheap, their current valuations don’t have to scrambling to take profits or igniting reluctance to buy. I actually see it as a reason to stay bullish, even if my expectations have come down a bit.

Power Prices Have Seen A Sustainable Fall

The second reason I remain long mainland European shares has to do with the fact that the Russia-Ukraine war remains contained in Eastern Europe. While this conflict is not “good” for any reason, the fear at the onset (and in the months that followed) is that it would spread into a more global conflict and impact central/Western Europe in a more direct way. This uncertainty clouded my outlook for European shares, and I remained fairly passive on the region.

It turns out my fears were a bit overblown, and Europe’s initial sell-off because of the conflict turned out to be a great buying opportunity. While I was a bit late to get in because of my caution, the gains have still been steady since then, so I don’t have many regrets. More importantly, my expectation is this conflict remains contained within the borders of Russia and Ukraine, and therefore I am not reluctant to have equity exposure to the Eurozone for the second half of 2024.

There are many reasons why this containment is good for investors. One in particular is that European consumers are no longer feeling the sting of rising energy and utility prices. Back in 2022 (and even in 2023) the threat of Russian supply chain challenges, tariffs, and cold winter weather all saw input prices rise dramatically for power. This created quite a shock for European households and hurt the consumer backdrop. While that pain was very real at the time, it turned out to be relatively short-lived compared to what could have been. Fortunately, prices moderated in late 2022 and have been at sustained lower levels for all of 2023 and early 2024 as well:

This is important for both investors in the region and for supporting consumer spending power going forward. It improves sentiment, confidence, and leads to broader consumer household spending since less is being tied-up in energy or power bills. The importance of this cannot be ignored, since funds such as FEZ (and others with primarily European large-cap exposure) are heavily tilted towards Consumer-oriented sectors:

What I see here is an improving macro-backdrop that is helpful to both businesses and consumers and looks to be on a sustainable course. Naturally, the war in Eastern Europe poses a headwind, but it continues to be so as more time goes on, and the conflict continues to be contained. With European ETFs so heavy on consumer exposure, this is a big deal for this investment thesis.

Eurozone Growth Accelerating

Another factor that I feel bodes well for Europe as a whole is that economic activity looks to be on a big upswing. This differs substantially from both the US and China – as well as other parts of the world. While other nations/economic zones may have more positive economic readings for the time being, eurozone activity has been picking up, and the growth has accelerated from the end of 2023 through today:

To be fair, one could view this in two different ways. It looks like the US could have the advantage here in terms of its economy expanding for longer than Europe. On the other hand, the market is forward-looking, and Europe’s recent acceleration of economic metrics suggests growth could be stronger in the months ahead than here at home. This all depends on one’s outlook and perspective, but for me, I see this uptick as a strong signal that Europe’s second half of the year will be a good one.

Any Risks? Naturally

Of course, no discussion of any investment thesis is complete without a look at some risks. Europe is no exception – there are plenty of things to be concerned about, as there are in any corner of the world. The primary threat that comes to mind is Russia – with respect to both its current war in Ukraine and its ambitions throughout the continent. It remains a wildcard that the rest of Europe needs to be keenly aware of – and that isn’t something that is going to change.

Besides just the geopolitical nature of souring Russian/Western relationships, there are economic implications. Russia has been pledging to cut its oil output to counter-balance sanctions imposed on them (by the US and western European allies) and to drive oil prices up in the short term. This is fairly consistent with the broader strategy of OPEC+ and we see that Russia still has room to move on cuts if it wants to hit its previously announced quotas:

If Russia continues down this course alone it won’t make a huge impact on the market, but if this is something that becomes indicative of more oil producing countries than it could have wider economic implications. Primary of which will be pain at the pump for global consumers – an area where I already mentioned has a big impact on European equity funds.

Another risk to consider is concentration risk. This is kind of ironic, since one of the reasons why myself (and I imagine many others) look outside the US is because of concentration risks rising here at home! With the Mag 7 – and other Tech stocks – continuing to exert their dominance over the equity market, the S&P 500 has become very reliant on their performance. So while branching outside US borders makes sense, readers should understand that other developed world indices suffer from concentration as well. Take Europe, for example. The Euro Stoxx 50 index – which FEZ tracks – is actually more top-heavy than the S&P 500:

What this tells us is that moving in to other indices – whether in Europe, Britain, or Japan, does not alleviate the risks posed by the top-heavy funds that track these countries. While European ETFs will give investors different underlying stocks, the overall performance will still be tied to just a handful of big companies. This offers opportunities but also challenges too – so be mindful that this is not an outright cure for market concentration risk.

Bottom-line

The market has rewarded investors in the first half of 2024, and I see some of the top sectors continuing to perform well in the second half of the year. This includes US large-caps, gold, and, as covered here, European shares. All of these themes have been on a roll, and I personally like this momentum:

Be mindful that nothing goes up forever, but momentum plays often last for a while. European stocks have plenty of wind at their backs in my view, so I don’t see recent gains as a reason to avoid this arena. As such, I will be building on my positions in FEZ and SCHF, and I encourage my followers to give those funds – and other ETFs that track Europe – some consideration at this time.