Coming up short. Europe began the year on a positive note amid a pickup in growth and sentiment, sparking optimism that the region’s economic difficulties might be receding. Promising signs of recovery had led to a hopeful outlook for the remainder of the year, but as the year progressed, momentum in European equities largely dissipated.

Eurozone GDP expanded 0.3% q/q in 2Q, the same pace as the quarter before, suggesting that the economy is recovering from last year’s stagnation. However, soft manufacturing and industrial production numbers continue to dim the growth outlook; despite earlier signs of improvement, the German economy fell back into contraction in the second quarter after recording a 0.1% decline in GDP, disappointing expectations of an upward revision.

Events in recent months saw heightened volatility in Europe markets. Europe stocks, though cheap, were not spared from the recent market rout triggered by weak US labour market data and a sharp unwinding of the yen carry trade; earlier on, French President Emmanual Macron’s abrupt call for snap elections had sent French stocks and bonds into a sharp selloff, triggering concerns of contagion risks. These risk-off events will dent investors’ appetite for European stocks in the short term.

No imminent rebound in sight. Despite already trading at steep discounts to US stocks, the unremarkable earnings season has failed to lift valuations. Of the 76% of companies which have reported their earnings (as of 26 Aug), only 54% have registered positive earnings surprises, mainly in the communications, financials, and real estate sectors. Growth in the financial sector has been subdued, with net interest margins likely to be compressed by further rate cuts. Meanwhile, the pullback in spending on autos and luxury goods continue to weigh on the consumer discretionary sector. 

Stay with resilient sectors. In the near-term, weak sentiment will further compress equity valuations, which are already near historic lows. Until we see a significant decline in bond yields or a substantial improvement in corporate earnings, the sustainability of gains in Europe equities remains doubtful. We maintain our underweight position on Europe equities, and highlight fundamentally driven sector-specific opportunities in the IT services and healthcare sectors, as well as select luxury players. We are optimistic on the utilities sector, which is likely to benefit from lower input costs as rates and oil prices decline, as well as an uptick in demand from AI-driven energy needs.

With healthcare playing a major role in Europe’s stock market, we remain cognisant of key risks facing the sector. Drugs such as Ozempic have been around for years, but have only made headlines recently due to their overnight popularity as weight loss agents.

Such drugs mimic a hormone (GLP-1) in the body that helps to control insulin and blood glucose levels, making them viable for diabetes treatment. A recent study by the American Journal of Medical Care found that nearly 40% of patients with type 2 diabetes discontinued their insulin medication within 12 months of it being prescribed – researchers noted that the results were particularly pronounced with people who started taking GLP-1 drugs. Companies must constantly innovate to stay ahead of the curve, or risk becoming obsolete.

That said, the healthcare sector remains subjected to strict regulatory controls. New EU rules announced this year have threatened to cut the number of new treatments for rare diseases because of stricter curbs on medical trials, potentially reducing treatment options for rare diseases. These rules may stifle investments into medical breakthroughs, as some pharma companies may be left with no choice but to abandon their research on rarer diseases.

Stay with quiet luxury. The global luxury sector is facing a period of uncertainty, as consumer confidence wanes over subdued economic growth and persistent inflation. McKinsey forecasts the sector to grow by 3–5% in 2024, down from 5–7% in 2023, as luxury spending continues to be weighed down by key growth drivers such as China. A 2024 survey by PwC suggests that shoppers are shunning luxury items in favour of essentials; about 40% of respondents anticipate that they will be spending less or nothing at all on luxury goods over the next six months.

Still, we believe pockets of growth exist. Markets such as Japan are emerging as new growth areas – Savills’ Global Luxury Retail 2024 Outlook shows that while new store openings fell 12% in China, the wider Asia Pacific region reported an increase in new store activity. Tokyo and Singapore were key behind this increase, helped by a pick-up in tourism and a weak yen, in the case of Japan. We maintain our view that luxury is a long-term structural growth sector; in particular, widening income gaps will highlight less price-sensitive and more exclusive, experiential driven demand. As the industry continues to be challenged by near-term headwinds, stay with quiet luxury brands that adapt to changing preferences and offer more than just material satisfaction, making them more resilient to economic downturns.

Renewables present fresh opportunities. Post the dual shocks of the pandemic and the Russia Ukraine war, European governments were alarmed by the region’s reliance on foreign supply of energy and fossil fuels. The ensuing energy crisis shored up the urgency in transitioning Europe to green energy – the EU has set a target to reduce net greenhouse gas emissions by at least 55% by 2030; alongside policies focused on increased deployment of renewables and energy efficiency, there is also a focus on the diversity and resilience of clean energy supply chains, both for manufacturing and for critical minerals.

In 2023, investment in renewables generation totalled almost USD110bn, an increase of more than 6% from the previous year, according to the International Energy Agency. Denmark and Germany remain at the forefront of the wind power sector in Europe despite ongoing profitability challenges, while Spain has led the surge in solar adoption to see wholesale electricity prices fall to record lows during periods of high solar output. A shift to cleaner and more secure energy sources is set to create significant opportunities to invest in renewable energy generation, grid networks for distribution, energy storage solutions, and new mobility.

Opportunities in infrastructure development. The need for infrastructure development is intensifying worldwide, fuelled by the aging of existing assets and the rapid expansion of opportunities across traditional and emerging sectors. Roads and bridges aside, modern infrastructure includes advanced assets such as EV charging stations, data centres, smart grids, and more. To tackle the concurrent challenges of climate change and deteriorating infrastructure, global infrastructure upgrades are crucial for enabling disruptive technologies and improvements in manufacturing capacities.  

As global politics become more fragmented, nations are focusing on energy security, supply chain resilience, and increasing domestic manufacturing, leading to new infrastructure projects. Developed markets, especially those in Europe, grapple with ageing infrastructure. The EU’s power grid, for example, averages 40 years old. To this end, the EU is investing heavily in infrastructure, including over EUR7bn in grants for transport projects, primarily railways. Additionally, the EU is contemplating a EUR100bn fund to boost defence manufacturing.

European companies poised to benefit from this long-term trend include those that specialise in: 1) engineering and construction services, 2) production of raw materials and composites used in infrastructure development, 3) manufacturing and distribution of heavy construction equipment and products, 4) infrastructure transportation, and 5) the production or sale of smart grid components.