Vytenis Šimkus. Has the European stock market reached its limit? | Business

In a decade, European stock returns have more than doubled behind the US. Stagnant economy, endless political and economic crises, lack of innovation led to the backwardness of the old continent. On the other hand, fears that Europe will soon become nothing more than a huge open-air museum are premature. Europe still occupies a pivotal role in the fields of pharmaceuticals, defense, industrial technology, therefore, despite the structural challenges, the outlook is better than can be formed by reading only the news headlines.

This year, the banking and retail trade sectors performed best in Europe, bringing in around 20 percent. return. At the time, shares in the auto industry, pressured by competition from China, fell by an average of 8 percent. At the level of individual sectors or companies, there are many differences, from industrial giant Thyssenkrupp, suffering from high energy prices and weak demand for steel and losing half its value this year, to Siemens Energy, which took advantage of the renewable energy boom and grew by 180 percent.

Favorable trends in the short term

While the pandemic and the energy price shock have slowed real economic growth, the shocks appear to have enabled Europe to break out of the deflationary trap that has weighed on corporate performance over the past decade. Higher prices for goods and services have allowed companies to significantly increase turnover and profit margins, which is one of the reasons why, despite the unstable economic environment, European stocks are at historic highs. Many analysts believe that inflation in Europe will be higher this decade, which will have a positive impact on corporate financial performance. Overall, European companies’ profits have grown faster than their share prices in recent years, so they still look reasonably “cheap”.

The European Central Bank’s interest rate cuts will also provide a positive boost. Lower interest rates will eventually lead to higher consumption and investment, leading to better corporate performance. Historically, the European Central Bank has struggled to wake up the economy with lower interest rates, but there are reasons to believe that “this time will be different.” Private sector debt is currently at its lowest level since 2009, and the financial sector is in a much stronger position, with high capital ratios and very few bad loans. Strong credit growth requires borrowers and lenders, it seems that both sides are strong enough this time, so a stronger impact of low interest rates can be expected.

Protectionism and belt-tightening

This is bad news for European companies as protectionist trends increase in the world. European companies are more dependent on export markets because domestic demand is historically quite low. The intensifying competition with China in the automotive and other traditionally European-dominated sectors also prompts cautious assessment of future prospects. China’s influence is currently twofold. Slow domestic economic growth is dragging down global commodity and energy prices, which is reducing costs for companies. On the other hand, for the same reason, Chinese manufacturers export more, creating more competition for European industry.

In recent years, governments in Europe have provided plenty of economic stimulus, but the rules of fiscal discipline are starting to come back into force, with states more likely to limit spending or raise taxes. This will inevitably have a negative impact on domestic demand in Europe, which means that it will also affect the results of companies. The last attempt for states to tighten their belts in 2011-2012. caused a recession. Some lessons have been learned, fiscal rules have been relaxed, so the negative effect will be milder.

There is room for growth, but the balance of risks is negative

The fundamentals of European companies look strong in the long term, and financial results should continue to improve. On the other hand, due to the risks and trends listed above, investors are cautious about European stock markets, which is why they are priced relatively cheaply compared to other markets. In comparison, the US market is less dependent on exports, dominated by service rather than industrial companies, and the government deficit strongly stimulates demand. These factors are reflected in the better performance of US companies and better stock returns.

The European stock market is dominated by more mature shares of traditional industries, often paying considerable dividends. Their prices fluctuate less, but their growth potential is also lower. For investors who want more stability or like a steady cash flow, this market can be a good choice. The current price of European stocks certainly does not signal an overvaluation or a bubble, but rather a sober assessment of growth prospects and risks.