Last July, we wrote a commentary titled “Europe – Always the Also-Ran?” where we highlighted the poor short and long-term equity performance of the European continent relative to the other global superpowers of the US and China. Despite the region being an economic behemoth, only behind the US in GDP, and the use of the common currency euro for much of the continent, the lack of political unity made coordinated government policy difficult, even in times of crisis. Basically, the EU government structure produced a bloated and ineffective bureaucracy lacking the ability to engender real change, let alone economic revival. We proffered, however, that the pandemic brought about a significant EU organizational restructuring, with a less bickering-stifled, decision-making process. This allows Europe to be a greater global economic force, which should be reflected in more competitive equity returns in the future.
Specifically, we noted the European Commission pandemic bailout package passed July of last year was momentous. At $869 billion spread over six years, this NextGenerationEU recovery plan paled compared to US support programs totaling trillions of dollars. But the idea that the European Commission was given the ability to issue bonds and specify how the funds will be spent gave the European Union greater political power, less impeded by the member consensus approach. This complements the European Central Bank monetary tools and provides a foundation for future stimulus, potentially creating greater economic vitality not just for EU-member countries, but the broader continent through its extensive trade network. Moreover, the recovery plan was just the beginning, as the new bond issuance revenue emboldened the EU to pass a much larger long-term budget known as the MFF, or multiannual financial framework. MFF’s projected spending for 2021 through 2027 more than doubles the level of spending for the seven years ending 2019.
It appears equity markets have noticed. Shortly after passage of the NextGenerationEU, we’ve seen more competitive European equity performance. From August 31, 2020 through June 30, 2021, the STOXX Europe 600 Index returned 25.58% in dollar terms compared to 24.34% for the S&P 500 and 16.09% for the Shanghai Shenzhen CSI 300 Index. The eurozone-only countries of Europe have performed somewhat better than the European-wide based STOXX, advancing 26.51%. True, part of Europe’s outperformance is explained by structural factors. Economic cyclical sectors like Financials, Energy, and Materials account for more of the European STOXX Index compared to the S&P 500 (28% versus 16%) and given the better pandemic control exhibited by both Europe and the US, these sectors benefited most from economic reopening, giving an edge to Europe’s index returns. Even excluding these sectors, though, Europe still ranks best in equity returns for the period, indicating sector breadth in its performance advantage. Of the top eight countries by weight, accounting for over 89% of the STOXX, only Germany and Switzerland lagged the S&P 500 over the last 11 months. Further, although valuations in some of the reopening-aligned sectors may be extended, strong growth lies ahead from over $850 billion in estimated excess savings in Europe. As in the US, so-called “revenge spending” is likely as consumers aggressively spend on travel, dining, and leisure in the second half of 2021.
In many newer industries, Europe is not playing catchup, but provides global leadership, and it’s important for investors to understand how the EU influences investment. One area to note is ESG (environment, social and governance), where the EU appears to be flexing its political muscle. The growing budget is designed not just to help the continent recover from the pandemic, but also to create more sustainable growth with an emphasis on clean energy and energy efficiency in transport and buildings. Indeed, in green finance, Europe dominates, issuing three times more ESG bonds in 2020 than in the US. In sustainable investment funds, Europe has more than five times the US in assets under management. Looking at electric vehicles, the US’s 1.1 million EVs on the road are projected to grow to 7 million by 2025, an impressive increase. But consider Europe, where the current 3.1 million EVs are expected to grow to over 20 million over the same period. Europe even compares well to China, the global leader in EVs. Europe sold 1.4 million EVs in 2020, more than China’s 1.2 million. In all industries, investors increasingly seek companies with better sustainability profiles, and Europe is the zeitgeist for this theme. The EU is typically the first to regulate, setting the toughest standards, and requiring the most transparency. These disclosure and operating standards define the requirements not only for companies based in the EU, but for any company hoping to do business within its borders.
The EU development plan also includes extensive digitalization progress. By 2030, the EU hopes to achieve gigabit Internet for everyone, 5G everywhere, digital IDs for 80% of EU citizens, complete digitalization of public administration, a digitally-skilled populace, and widespread e-Health services. The EU wants to double its global market share of semiconductor production, including the development of the most powerful, cutting edge, and sustainable processors. Plans call for 75% of EU companies to use Cloud, AI, and Big Data, and the continent should have quantum acceleration computing capabilities. The EU’s methods to encourage compliance are likely to push the private sector to meet these goals. We note Europe already determines requirements in the digital rights space globally.
Clearly, the EU’s power is growing and it strongly encourages member states to pursue its stated goals. Its influence is not just through the financing it provides, but also by fostering a shared vision of European values. Countries not on board receive a swift rebuke – notice the EU’s response to Hungary’s new bill banning LGBTQ content in schools. With the EU’s increasing clout over the continent, it’s important to incorporate policy directives into investment themes. Europe leads in climate change, digitalization, and other emerging investment areas spearheaded by this more assertive EU. This will create investment opportunities for companies able to help the EU achieve their vision. Many European companies receive direct government support for these objectives and have developed greater competency in dealing with the continent’s extensive, complicated regulations. This gives them an advantage compared to non-European firms, suggesting an expanding list of Europe-based global-leading companies, and more competitive returns for European equities in general. We intend to participate in these opportunities with our ACM International ADR and global strategies.