Interview
The Future of European Equities
- Markets are demonstrating an unusual willingness to overlook significant economic scarring, including:
- Projected long-term unemployment increases.
- GDP levels failing to recover to 2019 baselines until at least late 2021 for quick unlockers like Germany.
- Recovery timelines extending to 2022 for slower unlockers such as the UK, Spain, and Italy.
- Market participants have absorbed a surge in new equity and debt issuance better than anticipated, contrasting sharply with the equity buybacks seen a year prior.
- Goldman Sachs Research defines the current market environment as the start of a new bull market, barring a second massive wave of virus-related lockdowns.
- Future market returns are characterized as "fat and flat," indicating:
- Wide ranges of volatility with generally positive but not strong secular returns.
- A ceiling on gains due to valuations already at historic highs, with US P/E ratios exceeding levels seen except during the late 90s tech bubble.
- Zero interest rates and highly accommodative policy limits the potential for a sustained strong rally similar to the previous decade.
- Valuation troughs occurred at significantly higher levels in 2020 compared to the 2008–2009 financial crisis (where P/E hit ~8), reducing the margin for upside.
- Sector rotation strategies are shifting toward alpha over beta, with index investments expected to underperform due to the "fat and flat" outlook.
- The prolonged secular outperformance of growth factors over value factors is not expected to reverse, despite recent short-term rotations into cyclicals.
- Long-term value opportunities are identified specifically in "mutating" companies that are transforming business models:
- Oil majors transitioning to broader energy companies with renewable investments.
- Automakers pivoting toward green investments and decarbonization.
- This specific sub-segment of value is preferred over a broad "value factor" bet, which is still forecast to underperform.
- European market performance is supported by a decisive, preemptive ECB response that prevented sovereign bond stress from building:
- The ECB extended its Quantitative Easing (QE) program significantly.
- Real caps were placed on sovereign spreads.
- Massive liquidity was provided to the banking sector.
- The proposed EU Recovery Fund is viewed as a critical fiscal catalyst, potentially more impactful than the ECB:
- Represents the first instance of decisive, coordinated fiscal action within the EU.
- Facilitates a fiscal transfer from Northern to Southern European economies hit hardest by the crisis.
- Financed innovatively through future EU budgets with no repayment required until 2028.
- Key investment themes for the coming months in Europe include:
- Digital Economy: Companies with online exposure, which trade at a discount to US tech peers despite higher valuations than the broader European market.
- Renewables: A sector outperforming year-to-date, characterized by superior growth prospects and only a slight valuation premium.
- Fiscal Infrastructure: Construction materials, capital goods (rail), and tech companies with government exposure, expected to benefit from potential fiscal spending resurgences.