By European stock market standards, the size of the SpaceX initial public offering (IPO) will be breathtaking. The company is expected to be valued at between $1.75 trillion and $2 trillion, and given how frothy Wall Street is right now, it would hardly be a surprise if it went to a substantial premium on its first few days of trading. We can all question the valuation. The Starlink business that now provides internet access on flights is a clear money-spinner and it may be able to break into domestic broadband as well, but the plans for a colony on Mars look, to put it politely, a little optimistic. Even so, this is a huge business and a very successful one, and it has created a huge amount of value in a very short period of time.

It is far from alone. Anthropic, the company behind Claude AI, is reported to be planning an IPO in October, with a valuation of $1 trillion or perhaps more. Its rival OpenAI, the company behind ChatGPT, is also expected to list later this year, with a value of close to $1 trillion. There are slightly smaller companies just behind it. Last week, Cerebras, which makes AI chips, made its debut on Nasdaq, and after a first-day premium, saw its value soar to $95 billion. On the US market, incredible amounts of wealth are being created at dizzying speed. Anthropic is only five years old, OpenAI is ten (its profit-making unit only five) and although SpaceX was founded in 2002, it only really got going a decade ago.

The contrast with European stock markets is painful. SpaceX by itself will be worth almost as much as the whole of France's CAC-40 (valued at €2.6 trillion and falling rapidly as the value of LVMH slumps). It will be getting close to the entire value of Britain's FTSE 100, currently valued at £2.4 trillion, and SpaceX and Anthropic combined will certainly be worth more than all of the UK's 100 largest companies put together.

European stock markets need more mavericks like Elon Musk

The reason is clear. Very few new firms are being created. If you exclude mergers, the newest company on the CAC-40 is Eurofins Scientific, which was formed in 1987. Even where there are new companies, the best ones choose to list on Wall Street – the Cambridge-based chip designer ARM, for example, is now worth $220 billion, which would rank it as the third largest in the FTSE 100 if it had decided to list here.

Europe, including the UK, needs to realise how far behind it has fallen and start working out how to turn that around. First, it should radically reduce the taxes on start-ups to encourage more entrepreneurs. Britain has scaled back the break on capital-gains tax that anyone who started a new company used to benefit from, and most of Europe never had any concessions to start with. Instead, there is a constant stream of new wealth taxes and capital-gains taxes, with the Netherlands extraordinarily planning to tax capital gains before they have even been cashed in. No wonder there are far fewer start-ups and hence fewer giants ever emerge.

European stock markets should also roll back restrictions on growth industries such as AI and space. While the US has a booming space industry, Europe has a Space Act; while huge new AI businesses are created on the other side of the Atlantic, Europe is stuck with an AI Act. But there is no point in having a regulator if there isn't an industry to make rules for. There is still little sign that politicians in either Brussels or London realise how much damage has been done by trying to regulate industries before they have even begun.

Finally, Europe should relax the listing rule for entrepreneurs such as Elon Musk who want to keep control of companies. SpaceX will come in for a lot of criticism for allowing Musk so much control over the business and the $1 trillion pay package if he manages to create a thriving human colony on Mars. It doesn't follow Europe's governance rules. But so what? Entrepreneurs are often a little odd, and they are often control freaks, but they also have the drive and ambition to create huge new businesses. Europe could use fewer rules and more mavericks if it is to avoid turning into an investment backwater, with nothing more than a dull collection of very old companies.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

For the last decade, it has been easy – and highly profitable – to allocate the marginal pound in your portfolio to the largest American technology companies. However, it now looks as if the “easy money” has already been made in this trade and investors should consider where growth will come from over the next decade, not the last one.

For investors considering opportunities away from the US, Europe is beginning to step back into the spotlight. Contrary to popular belief, European stocks are not a legacy trade. Although the continent's large-cap indices lean heavily on traditional sectors, its small- and mid-cap segments – which comprise more than 2,000 companies – are awash with innovative businesses, which often command a dominant share of their sectors while being virtually unknown to most investors.

Three European stocks to consider

Our fund heads off the beaten track to identify European stocks that may be beyond the radar screens of larger funds and outside the reach of most analysts. Alongside a proprietary screening process, we travel around Europe on a weekly basis meeting management teams to assist us in building a high-conviction, concentrated portfolio of European stocks. Because we invest in smaller companies, we can build very deep relationships with them, engaging closely with management.

This part of the market has been through a challenging period in recent years, but the pandemic, the resurgence of inflation and the subsequent rise in interest rates have forced businesses to adapt, making European small-caps far more resilient than most people realise. With the market only just beginning to recognise the quality of these businesses, they may not remain small caps for long.

As the continent faces up to its need significantly to renew and strengthen its often creaking infrastructure, Netherlands-based Royal BAM Group (Amsterdam: BAMNB), a construction and infrastructure company, is well placed to profit. The group could be a major beneficiary of greater government spending on infrastructure in the coming years and it has a significant backlog of orders coming through its pipeline. The market has begun to recognise the quality of the company in recent years, but we believe it has further to run as infrastructure spending continues to gather pace across Europe.

AcadeMedia (Stockholm: ACAD) is a Swedish company that has broadened its geographic footprint across the Nordics and into Germany, providing early-years education. It is largely disconnected from macroeconomic shocks such as the oil price or US tariffs and enjoys a dominant position in its sector. The business is highly cash-generative and demand for its service in the future should remain robust. The stock is trading on an attractive price/earnings ratio of 11, making it an interesting long-term opportunity.

Einhell (Frankfurt: EIN), based in the Bavarian countryside, is a developer and manufacturer of DIY and power tools. The business led the way in developing battery-operated tools and is globally competitive on a cost basis, even against Chinese competitors. Einhell is starting to expand its reach across Europe and further afield.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Europe has lagged behind the US for years now, but what would it take for the continent to recover?

Daniel Avigad, manager of the TM Lansdowne European Special Situations fund, speaks to MoneyWeek's Andrew Van Sickle about opportunities in European equities, solving the continent's growth problem, and the consequences of populism.

You can watch the episode on our YouTube channel or subscribe to MoneyWeek Talks on any podcast platform.

About the podcast

MoneyWeek Talks is a podcast that helps you unlock the secrets to financial success. Editors Kalpana Fitzpatrick and Andrew Van Sickle are joined by influential guests – from CEOs and entrepreneurs to economists and policymakers – to share their top tips on managing money, investing wisely and building wealth.

Subscribe to the MoneyWeek Talks podcast and get ready to make it, keep it and spend it with confidence.

Sustainable dividend growth is often a hallmark of quality and capital discipline in a business. Companies that consistently return cash while reinvesting for future growth tend to benefit from durable competitive advantages, strong balance sheets and resilient cash flows. The sustainability of dividends is therefore a core pillar of our investment process.

As active, bottom-up investors, we target attractively valued firms offering structural growth and the ability to compound dividends over a three-to five-year horizon. To find them, we seek companies with robust business models, effective capital allocation and financial strength, which enable them to reinvest at attractive returns while steadily increasing payouts. Long-term wealth creation comes from businesses that can profitably reinvest cash flows over time. The following stocks illustrate our philosophy.

Three European stocks to consider for your portfolio

ASML (Amsterdam: ASML) is the world's leading supplier of photolithography systems to the semiconductor industry. It serves 17 of the top 20 chip manufacturers and is the sole provider of extreme ultraviolet (EUV) lithography systems: technology essential for manufacturing the most advanced semiconductors. This unique positioning effectively grants ASML a monopoly in EUV, underpinning significant pricing power and structural growth.

As AI, cloud computing and the proliferation of software accelerate digitalisation and the demand for increasingly complex chips, ASML offers impressive long-term growth prospects. Gross margins exceed 50% and free cash flow-conversion is strong.

Combined with formidable technological barriers to entry, these characteristics define a high-quality franchise capable of compounding value over the long term. The dividend has grown steadily over many years and would yield around 30% based on our entry price. Compounding companies are not confined to the technology sector. In healthcare, Roche (Zurich: ROG) is a global leader with top-tier positions in oncology, immunology, neuroscience, virology and diagnostics. Despite industry headwinds including patent expiries and the post-Covid normalisation in pharma's revenues, Roche has shown it can sustain profit growth. This resilience reflects its diversified portfolio, innovative pipeline and rigorous risk management. Recent clinical successes in areas such as breast cancer and multiple sclerosis have bolstered its long-term growth prospects.

Disciplined capital allocation is key to Roche's strategy. It consistently leads the industry in research and development spending, prioritising long-term innovation while generating attractive returns on investment. This has supported its progressive dividend policy, with payouts rising for more than 30 consecutive years.

Sanpaolo (Milan: ISP) is Italy's largest banking group. The European banking sector is structurally stronger than at any time since the financial crisis. Capital ratios are far higher and risk exposure on balance sheets has declined; cost structures have improved and net-interest income has climbed sustainably. Yet valuations still reflect legacy concerns. Intesa stands out for its diversified business mix, strong profitability and disciplined risk management. It is well capitalised and operationally efficient, underpinned by a stable retail-deposit base. While earnings growth may moderate as rates normalise, the bank's conservative leverage and limited reliance on capital markets continue to bode well. Intesa's attractive dividend yield and resilience under stress make it a compelling long-term investment.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Europe presents a mixed backdrop, with varied political priorities and differing fiscal positions across major economies. Yet many European companies are global leaders in their fields and continue to grow despite muted domestic GDP and new US tariffs. These firms often generate earnings well beyond Europe’s borders, operate in niche markets where expertise matters and provide essential products and services that remain in demand regardless of short-term uncertainty.

The European Opportunities Trust (EOT) invests in a focused number of “special” European businesses that the manager believes have limited downside and can grow consistently over many years. The trust looks for companies with strong competitive positions, global reach and business models that remain relevant through economic cycles, resulting in a portfolio that differs significantly from the index, the MSCI Europe. The following examples illustrate some of the qualities that EOT looks for in its investments.

Three European companies to consider

Gaztransport et Technigaz (Paris: GTT) designs specialist containment systems used in the transport and storage of liquefied natural gas (LNG). GTT’s technology is used in most of the world’s largest LNG carriers, reflecting decades of engineering expertise and strict safety certification standards that competitors have found hard to replicate. Global demand for LNG is expected to continue rising in the years to come.

Following the lifting of the US moratorium on new LNG developments, 10 major liquefaction projects have now been approved worldwide, six of which are in the US. This should translate into a surge in demand for new LNG carriers fitted with GTT technology. We view this long wave of investment in LNG projects as a structural tailwind rather than a short-lived cycle.

Ryanair (Dublin: RYA), Europe’s leading low-cost airline, continues to deliver impressive growth. The company maintains the lowest cost base of any major airline and has widened its lead over rivals. The company has a strong balance sheet, allowing it to own rather than lease its aircraft, and to standardise its fleet and optimise maintenance practices, all of which contribute to keeping a lid on costs.

This creates a virtuous circle, whereby Ryanair can make bulk orders of next generation aircraft, which carry more passengers with better fuel efficiency. This cost advantage enables Ryanair to offer lower fares, attract more passengers and fill planes consistently, even when consumers’ budgets are tight. We see Ryanair as a structural winner in European aviation. The business continues to gain market share and remains resilient despite higher interest rates, elevated operating costs and fluctuating economic conditions.

Genus (LSE: GNS) is a global leader in animal genetics, helping farmers improve herds’ health and productivity through advanced breeding programmes. One of the most important long-term developments for the company is the US regulatory approval of its PRRS-resistant pig. PRRS, or porcine reproductive and respiratory syndrome, is a costly viral disease that weakens young pigs and disrupts breeding herds, leading to substantial losses across the industry.

A resistant herd can materially improve survival rates, yields and overall efficiency, offering producers clear economic value. Further regulatory approvals in the coming years are expected to be followed by commercial adoption. The scale of the US market and the global prevalence of PRRS provide a strong foundation for durable growth.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

It is not just the London Stock Exchange that has been suffering a relentless decline. It is happening right across Europe’s main bourses. There was a 15% decline in initial public offerings (IPOs) across the continent in the first half of this year compared with 2024, according to accountants EY. Measured by revenues raised, the decline was 50%. The bulk of the IPO market is now in the US, China, India and the emerging stock markets in the Gulf. Europe is falling behind. Just as in London, firms have been leaving the markets, or have been taken over, and very few new companies have been coming through to replace them.

German chancellor Friedrich Merz has a solution. “We need a kind of European stock exchange so that successful companies such as biotech firms from Germany do not have to go to the New York Stock Exchange,” he told the German parliament last week. “Our companies need a sufficiently broad and deep capital market so that they can finance themselves better and, above all, faster.” Instead of separate exchanges in Paris, Frankfurt, Milan and Madrid, a single unified bourse could list all of the continent’s major companies, offering a scale and depth to match New York.

A single, unified exchange would be a lot simpler for investors, especially from North America and Asia. It would have access to a lot more capital, which might mean valuations were higher. True, with Euronext, which links the Netherlands, France, Italy and Portugal, we already have that. But a pan-European exchange would go a lot further. The London Stock Exchange, which has already dropped out of the top 20 for global listings and has seen a relentless decline in the number of companies traded, would almost certainly join. It is in bad enough shape already, and if a new European exchange were formed, it would be even more irrelevant than it is already if it were not part of it.

Would a single European stock market fix anything?

The catch is that this is just the same old, tired formula of more integration that has dominated policy-making in all the major European countries for the last 30 years. It hardly begins to address the major issues facing every European stock market. Firstly, the whole of Europe has imposed far too many rules and regulations on listed companies. In the City, there are an endless series of governance codes to comply with, including diversity quotas for boards and restrictions on executives’ pay, but it is just as bad across the EU. Companies with more than 500 employees have to comply with rules on sustainability and supply chains that typically run to hundreds of pages. Each one might be well intentioned in itself, but taken together, they add to the cost and complexity of listing a company.

Secondly, crushing taxes and rules across the continent mean there are few new growing companies. The US has an estimated 700 tech unicorns, as start-up companies with a value of more than $1 billion are known, compared with fewer than 200 in the EU, despite the fact that it has a significantly larger population. Companies such as OpenAI and SpaceX have valuations that already run into the hundreds of billions, far larger than anything that is coming out of Europe. In short, Europe does not have nearly enough new companies, the ones that it does create don’t grow quickly enough, and even the handful that do emerge don’t find listing their shares very attractive.

It is hard to see how a single European stock market will do anything to fix any of that. It won’t mean that the listing requirements are less of a burden. In fact, given all the compromises that will be required to make it happen, and all the extra powers that are likely to be handed over to EU officials to regulate it, it will probably make them worse. And it won’t do anything to lighten the taxes or the regulatory overload that now makes it so much harder to start a business in Europe than it is in the US, the Gulf, or much of Asia. All it does is double down on the failed centralising strategy of the last 30 years. It would be far better to have national bourses competing to offer the most attractive forum for listing a company. Having a single stock market won’t make any difference.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

When conservative billionaire Pierre-Édouard Stérin caught the eye of Le Monde last year, the newspaper noted how stealthily he was “advancing his pawns” in the chess game of hard-right French politics. A tax exile based in Belgium, Stérin had just been outed as the financial force and guiding spirit behind Pericles, “a secret, wide-ranging project aimed at boosting right-wing forces” and restoring “France’s grandeur”, to quote Politico. The timely leaking of internal documents – in which the shady group vowed to achieve “the successful exercise of power at the earliest opportunity” – caused a sensation in France, unleashing a potent mix of conspiracy theory and patriotic debate. The country’s current political chaos provides ample opportunity for a re-run.

Stérin is leaving no stone unturned in his quest to revive France with his bespoke prescription of retro Catholic morality, dry economics and a hardline “re-migration” message that even Marine Le Pen’s National Rally party dubs “toxic”, says The Times. He has spent hundreds of millions of euros at the grassroots, with education a key target. In addition to ridding France of “the woke insanity imported from American universities”, he’s planning “a network of Christian private schools”. He’s also an investor in Studio 496, whose mission is to conserve the heritage of “La France profonde” by sponsoring activities such as village fetes. More overtly political projects include a Parisian think tank and a training college for would-be candidates.

Some call “the billionaire who wants to make France great again” the country’s Elon Musk. In truth, he’s more “eminence grise” – happiest pulling strings from the shadows, says Politico. A self-described introvert, with “a tendency for extreme rationalism”, Stérin famously ranks new acquaintances on a scale of one to ten on a dedicated Excel spreadsheet. His wife Amandine wasn’t exempt. He scored her on a strict set of marriageability criteria before popping the question. Fortunately, she delivered – quite literally: bearing her “pronatalist” husband a fine family of five. He’s raising them on tough love, telling the French financial weekly Challenges that they won’t inherit anything. “It’s a real freedom to start with nothing in life.”

Stérin, 51, grew up in a middle-class family in Evreux, a town in Normandy, where he began his career as an entrepreneur at the age of 13, selling RAM sticks for video games, says The Times. He launched 20 failed businesses before striking gold. Smartbox, a gift-box provider specialising in short breaks, proved hugely popular and established his financial clout. These days his investment firm, Otium Capital, has assets ranging from tech to health.

Stérin has donated generously to Le Pen’s party, but says he is keeping his options open – viewing the popularist Rally party as too wedded to the state in its “dirigiste” economic thinking and too liberal on social matters such as abortion. Nonetheless, the links run deep, says Politico. The CEO of Stérin’s Otium fund, François Durvye, is also “a member of Marine Le Pen’s inner circle and one of her most trusted advisers”.

Pierre-Édouard Stérin is reaching for heaven

By US standards, Stérin’s wealth – he is said to be worth €1.6 billion – and political largesse look trivial. But the rules on political donations in France are much tighter, and he has been in the crosshairs of prosecutors. Stérin is now in the frustrating position of being a wealthy backer in search of a candidate. But for the moment, he is attending to his soul. “By giving away my fortune… I am optimising my chances of eternal life,” he told Catholic daily La Croix. Typically, he’s researched the process thoroughly. “I typed on Google: how to become a saint.” It is “an ultra-motivating stimulus to get up in the morning”.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

The apologists for the relentless expansion in the size and cost of Britain’s public-sector debt like to point out that other major developed economies face a similar predicament.

Although government bond yields have risen further and faster in the UK than elsewhere, they have also increased sharply in the US, Germany, France and Japan, countries with – except for Germany – higher debt relative to GDP. If Britain is on the wrong path, then it is a path endorsed by everyone else.

Where have we heard this argument before? In early 2020, the governments of nearly every developed country imposed lockdowns in an attempt to prevent the spread of Covid. Scientists advising the UK government advocated a policy of lockdown for no more than nine weeks.

However, the government found lockdowns to be popular, enjoyed the micro-management of people’s daily lives and relished the task of crisis management. Only reluctantly did it lift all restrictions at the end of 2021, having incurred vast financial costs.

This was the greatest political, financial and social disaster for more than 100 years, instilling in the population a culture of hypochondria and dependence on the state that has proved extremely difficult to shift. The benefit to the nation’s physical health was, at best, doubtful.

Only one country broke ranks and followed a very different path with no lockdowns: Sweden. So, perhaps Sweden, rather than the US, Japan and the rest of Europe, can teach us how to manage our economy?

In the 1980s, leftists saw Sweden as a socialist utopia for its all-embracing welfare state, stringent regulation and high taxes. Moreover, the country remained a democracy, although the same party, the Social Democrats, had been in power almost continuously for 50 years. Why couldn’t Britain follow the Swedish example?

How Sweden turned its economy around

While Britain’s national debt-to-GDP ratio has risen from 79% to 96% in the last ten years, Sweden’s has declined from 46% to 34%. Swedish ten-year government bonds yield 2.5%, compared with 4.7% in Britain, so its debt-servicing costs are a fraction of the UK’s. Sweden certainly benefited from having largely avoided the extravagance of lockdown spending, but the UK’s debt ratio had been rising steadily since 2000, from 28% to 77%.

The gulf in yields and debt loads has come about because Sweden suffered an economic crisis in the early 1990s and made a radical change of course. With a fiscal deficit of 11% of GDP in 1993, a debt-to-GDP ratio of 90% and the economy in deep recession, the Social Democratic government made deep cuts to public spending.

Fiscal retrenchment was 8% of GDP over four years, two-thirds from spending cuts, notably to benefits, and one-third from tax increases. The currency was devalued, interest rates fell, and economic growth returned. Mass privatisations followed.

The economy ground to a halt in 2023, but real growth in GDP per capita has averaged more than 1% for the last ten years, compared with 0.75% and slowing for the UK. Swedish inflation is a little over 1%, the UK’s is nearly 4%.

Sweden’s tax-to-GDP ratio, according to the OECD, is high at 41%, but the government has just announced $3 billion of tax cuts, bringing it down. Adjusted for population, this is equivalent to nearly £15 billion in the UK. The UK’s tax-to-GDP ratio for 2024-2025 is estimated at 39%, but with UK public spending accounting for 45% of GDP, the UK’s tax take will inevitably leapfrog Sweden’s.

VAT, at 25%, is higher than in the UK, but since 2005 there has been no inheritance tax, and since 2007, no wealth tax. Moreover, “the Swedish welfare system is based on the general principle that everyone contributes and everyone gets equal access”. The tax system is progressive, but does not try to load the burden as heavily as the UK on “those with the broadest shoulders”.

The Swedish stock market is in rude health. In the ten years to March 2024, 501 companies listed in Sweden, more than the number in France, Germany, the Netherlands and Spain combined and lagging only the UK at 765.

Since then, there have been more flotations in Sweden than in the UK, although Klarna, the $50 billion Swedish fintech company, chose to float in New York rather than Stockholm this month. The number of listed companies has fallen by a third in ten years.

About 40% of the Swedish stock market is owned by domestic pension funds, while 25% of adult Swedes invest directly; 70% own mutual funds. The equity market has doubled in the last ten years, while the UK’s All-Share index is up 50%. No British leftist advocates following the Swedish example nowadays.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

It’s difficult to imagine a time when anybody was more bullish on Europe than America, but this was a popular investment thesis before the global financial crisis. The US had a giant housing bubble, a vast trade deficit and a currency in steady decline. Consumers were heavily dependent on spending their savings, according to statistics at the time (this data later got revised, and those eight quarters with a negative savings rate turned out to be an error – a good example of how unreliable statistics can be, as I discussed last week). Europe also had housing bubbles, but otherwise looked sounder and was well placed to benefit from emerging market growth.

We all know how this theory turned out. Europe has trailed the US on virtually every financial measure since the crisis (one can very fairly argue that Europe still offers a better quality of life in many ways, but that’s not what we are looking at). The reasons for this go beyond the idea that America is simply more innovative and dynamic, with a whole series of events working against Europe or for the US.

The eurozone debt crisis dragged on far too long, with far too much can-kicking. The shale revolution created a huge advantage for US growth and for the trade balance. Regardless of one’s views on Brexit itself, most people would acknowledge that the process was a distracting, exhausting upheaval for both Britain and the EU. Most recently, Russia’s invasion of Ukraine turned an energy disadvantage into a crisis, put a full-scale war on the borders of a continent that was complacent and completely unprepared for it, and sent uncertainty and fear rocketing. Look back at all this and maybe we should be amazed that Europe hasn’t done even worse.

Still, it didn’t help that Europe put its head in the sand much more than America when cleaning up its banks after the crisis. US policymakers did not exactly get this right – banks were bailed out too freely, there was no accountability for the actions that led to the crisis, and interest rates were cut too low and stayed there too long. Yet its bank stress tests were a success: they led to clear recapitalisation plans, restored confidence in the sector and left banks able to lend again.

European banks stocks are accelerating

Europe’s stress tests were a fudge, and markets knew it. Banks were not recapitalised quickly: they only gradually recognised bad debts while they rebuilt capital. Ultra-low interest rates hurt profitability and made this process slow. That meant that they were in a weak position to lend, even if demand was there. So, US bank shares far outstripped European ones for the next decade.

Yet on the eve of the pandemic, European banks were finally in better shape. After shares bottomed in April 2020, they began to rally. Since 2023, they have beaten US banks and are accelerating. Valuations are rising: the Euro Stoxx Banks index is on a price/book of 1.1, up from 0.7 two years ago. Banks are highly cyclical, and I never like the sector, but they are central to the economy. If Europe is to regain ground against the US this decade, they should have further to run over the long term.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

European stocks were hit hard by the outbreak of war in Iran and the Middle East, leaving investors concerned about the region and considering whether it still represents a good investment opportunity.

As a net importer of energy, the continent stands to be heavily impacted by higher oil prices and increased inflation as a result of the conflict.

But there are still opportunities to be found, as long as investors are willing to be selective and know where to look.

“The conflict with Iran has raised global economic risks, especially for importers of energy such as Europe and the UK,” said James Flintoft, head of investment solutions at AJ Bell.

The Stoxx 600 index fell 9.6% in three weeks from 27 February, amid a broader global stock market panic that saw the Korean exchange implement a circuit breaker.

Often in investing, times of panic create buying opportunities for those that can keep their heads. So, amidst the broad selloff in European stocks, are there some sectors that could show resilience?

Could European energy stocks benefit from higher oil and gas prices?

One obvious European sector that could benefit from the recent turmoil is energy. Marcel Stötzel, co-portfolio manager of Fidelity European Trust and Fidelity European Fund, highlights that some European energy companies are relatively appealing in terms of their valuations compared to international counterparts. TotalEnergies (PA:TTE), for example, trades at a lower forward P/E ratio than BP, Shell or Exxon Mobil as of 23 March.

Read more on three other European stocks Stötzel recommends for long-term growth and income.

The Stoxx Europe 600 Energy index, which holds European stocks in the energy sector, gained 8% between 27 February (prior to the outbreak of the war) and 23 March. TotalEnergies gained 13% over the same period.

Could European defence stocks rise on geopolitical tensions?

Defence stocks tend to rise when global conflicts ramp up; there is a fairly direct link between geopolitical turmoil and higher spending on military equipment (like drones and ammunition) and defence technology spending.

Europe’s defence stocks have performed particularly well since the beginning of 2025. Trump’s return to the White House has brought a renewed emphasis on European self-sufficiency when it comes to defence, which appears to have kicked governments into gear about making up for decades of underspending.

This was brought into sharp focus when Trump made his desire for greater US control over Greenland clear earlier this year.

“[European] countries are going to go from sub-3% [of GDP spent on defence] to 3%, 4% or even 5%,” said Stötzel. “That would be very strong growth rates; we’re talking very healthy double digit top-line growth.”

There is a catch, though, in that recent rises have made lots of European defence stocks expensive. Rheinmetall (DE:RHM) trades at over 70 times trailing earnings; Saab (STO:SAAB-B) trades at around 60 times on the same metric.

“It’s a tough setup for defence stocks, because a lot of them have baked in around 10 years [of growth],” said Stötzel. “It feels like quite a big risk.”

For that reason, Stötzel’s portfolios are underweight European defence stocks, though they hold MTU Aero Engines (DE:MTX), a German aerospace company that derives around 20% of its revenue from defence contracts, mostly with the German air force.

What is the outlook for European infrastructure?

Similarly to defence, European infrastructure is set to benefit from spending increases that were unlocked last year, not least the German debt brake agreement that unlocked €500 billion in extra potential spending on infrastructure and defence.

The continent is entering into a multi-decade programme wherein governments and companies are investing in renewing ageing infrastructure assets.

European infrastructure stocks are “shaped by sustained investment commitments rather than near-term economic cycles”, said Pierre Debru, head of research, Europe at asset manager WisdomTree. “Capital is increasingly being directed toward energy networks, transport and digital infrastructure as Europe prioritises security of supply, modernisation and resilience.”

While the phenomenon is usually associated with the US, Europe is also undergoing its own AI data centre building boom.

France, in particular, is an attractive location for data centres because it has abundant cheap nuclear power.

“You also see some of the Nordic players signing some big deals, because they have cold temperatures, which helps with cooling,” said Stötzel.

Is there a buying opportunity in European mining stocks?

European mining stocks have also been caught up in the selloff following the outbreak of the conflict. The Stoxx Europe 600 Basic Resources index fell 13% between 27 February and 23 March.

But Asad Farid, portfolio manager of the JSS Sustainable Equity – Strategic Materials fund thinks that this presents a buying opportunity for investors, as some metals prices could rise as a result of the conflict.

“Aluminium is unique,” said Farid. “The Middle East accounts for 8 to 9% of global production, with Qatar, UAE, and Bahrain being the top producers.” Not only will the conflict restrict the supply of aluminium, but higher electricity costs will also benefit companies like Norwegian aluminium Norsk Hydro (OSLO:NHY) because Asian competitors will be harder hit.

He added that copper prices could rise, since mines in DRC and Zambia depend on imported sulphur, largely from the Middle East, for oxide ore processing.

How to invest in European stocks

Several investment trusts offer exposure to European markets; the largest of these by market capitalisation (as of 23 March) is Fidelity European Trust (LON:FEV), which merged with the second largest, Henderson European Trust, in September.

The next largest are JPMorgan European Growth & Income (LON:JEGI) and BlackRock Greater Europe (LON:BRGE).

Investment trusts offering exposure to European small caps include The European Smaller Companies Trust (LON:ESCT), JPMorgan European Discovery (LON:JEDT) and Montanaro European Smaller Companies (LON:MTE).

There is also a wide range of exchange-traded funds (ETFs) that offer exposure to Europe, either broad-based or thematically.

Some broad-based European index funds are the Amundi MSCI Europe UCITS ETC (LON:MEUG) or the FTSE Developed Europe ex-UK UCITS ETF (LON:VERG).

For energy exposure the iShares MSCI Europe Energy Sector UCITS ETF (LON:ESIE) tracks the MSCI Europe Energy 20/35 Capped Index (which contains large and mid-cap European energy stocks, with the weighting of the largest holding capped at 35% and all others capped at 20%). Shell, BP and TotalEnergies are the three top holdings as of 20 March.

For targeted infrastructure exposure, the WisdomTree Europe Infrastructure UCITS ETF (LON:WINF) launched on the London Stock Exchange on 18 March. Or for exposure to European defence stocks, you can choose from iShares Europe Defence UCITS ETF (LON:DFEU), WisdomTree Europe Defence (LON:WDEP) or HANetf’s Future of European Defence Screened UCITS ETF (LON:NAVY).

Last year, Henderson European Focus Trust and Henderson EuroTrust merged to form Henderson European Trust (LSE: HET), with £680 million of assets (after significant cash exits) and a well-regarded management team in charge. Just a few months later, though, the co-managers left Janus Henderson, and the combined trust will now be merged into the larger Fidelity European Trust (LSE: FEV).

The three- and five-year investment records of FEV and HET are already very similar at 33% and 74%. This is behind JPMorgan European Growth & Income (LSE: JEGI), on 46% and 99% respectively, but ahead of the rest of the sector. The enlarged FEV, with £2.1 billion of assets, should now have better liquidity and will aim to maintain a mid single-digit discount to net asset value (NAV). Fees should be lower, and the dividend yield moderately higher.

On the negative side, an average holding size of nearly £50 million for the 45 holdings will severely limit the ability of FEV to invest in smaller companies. This has not been a problem in recent years, with smaller companies underperforming, but it could be in the future. Investors may want to hold a European smaller companies specialist trust as well.

Focus on growth

FEV looks for companies that produce improving dividend growth “as this indicates steady structural growth”. Their criteria include a good performance record, a good return on capital, the ability to generate cash and structural but not acyclical growth. This is summed up as “good quality at a reasonable price”. They dislike companies with high levels of borrowing.

The focus is on stockpicking rather than reading the macroeconomic or geopolitical tea leaves. “Although the outlook for continental Europe is uncertain and faces challenges, we are excited about the prospects for the individual companies in which we invest,” says co-manager Sam Morse. “European companies have often kept pace with global indices because they are less and less reliant on the domestic European economies – two-thirds of sales and profits now comes from outside Europe.”

Stocks are generally held for three to five years, with no holding over 4% of the portfolio. The largest holdings – SAP, Roche, ASML, Nestlé and L’Oréal – reflect a bias to growth, but banks, energy and basic materials are also well represented. These top five explain why FEV has fallen behind JEGI in the last year – ASML, Nestlé and L’Oréal had a miserable second half of 2024, falling 25% in value on average. Only Nestlé has had a respectable (but dwindling) recovery in 2025, rising 9%.

First-rate European funds

Both FEV and the smaller JEGI (£525 million of net assets) are first-rate funds trading on low discounts to NAV. JEGI has the higher dividend yield at 4% against 2.25% for FEV, supplementing its income with payments from capital. Exposure to smaller companies is via a holding of 2.5% in its sister trust, the £640 million European Discovery Trust (LSE: JEDT), whose performance has been revitalised in the past year by management changes.

JEDT’s largest rival in the sector has been the European Smaller Companies Trust (LSE: ESCT). This trust recently bought back 42% of its share capital following a hostile takeover attempt by Boaz Weinstein’s Saba Capital (which sold its 30% stake in the buyback), but is now regaining scale by absorbing the dismally performing European Assets Trust (LSE: EAT). This will take net assets back up to £780 million, providing better scale and liquidity and lower management costs. However, the decision to double the dividend yield to 5% by paying out of capital looks impetuous.

The European trust sector may be shrinking but in both the mainstream and smaller companies sector, investors still have the luxury of choice.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

When Donald Trump began unveiling his tariff plans in April, investors feared we were entering a sharp and sudden bear market. Stocks dropped sharply around the world, with the US down 10% in two days. Yet the plunge was short-lived: stocks rallied as abruptly as they had dropped. The US and other major global markets have gone on to new highs. So did investors get rattled too easily – or are they too sanguine now?

On the optimistic side, the deals that the US is striking with trading partners look less damaging than everybody feared in April. Yes, tariffs are unwelcome. They bring complexity and friction to global trade and add costs. Those costs will be borne to varying extents by the entire supply chain between foreign exporters and US consumers. Yet these deals still reduce the risks of a wider and more damaging trade war.

The pessimistic take is that America’s views on the rest of the world have changed. It is backing away from principles that it has championed for decades to become insular and mercantilist. Policymaking is more arbitrary and unpredictable. We can’t even be confident that these deals – which are still broad frameworks – will be honoured, let alone what might come in the next three-and-a-half years and beyond.

US stocks vs the world

So the rest of the world is reacting in a rational way. Countries are striking deals with the US to minimise immediate disruption, but over the longer term they will have to recognise that the world is changing. Trade patterns and alliances will shift. CEOs are also trying to flatter Trump by announcing large investments in the US to avoid being targeted – we are seeing plenty of this from pharma firms in an effort to ward off threats of high tariffs on imported drugs. Yet it remains to be seen how much will be puffing up investment that was already in the pipeline and how much actually materialises.

We will be looking at how all this could play out at Turmoil, Tariffs and Trump 2.0, our next annual MoneyWeek Wealth Summit on 7 November (tickets have just gone on sale at moneyweekwealthsummit.co.uk/2025). However, in stock market terms, there is one obvious idea for managing these risks.

US stocks have so far outstripped the rest of the world over the past 15 years that they now make up 60%-70% of the global market, depending on which index you track. This has been driven by superior earnings growth, but valuations have also diverged much more than many investors realise.

The MSCI USA trades on 23 times forecast earnings, while the MSCI Europe is on 14. Look back to mid 2016 – about the time the divergence accelerated – and the MSCI USA was on 17 times forward earnings, while the MSCI Europe was on 15 times. So striking a better balance between the US and the rest of the world than a typical global tracker fund doesn’t need to be a bet on whether Trump’s policies will ultimately hurt the US. Doing so is increasingly justified by the growing gulf in valuations.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

European shares are enjoying their strongest start to a year since 2000 relative to US stocks, says Valerio Baselli on Morningstar. Over the past decade, capital has flowed from Europe to America in pursuit of better returns, but now the trend has reversed. European equity funds enjoyed €26 billion in net investment inflows in the first quarter, with this quarter set to be even better after global money managers were spooked by Donald Trump’s tariff drama in April. The pan-European Stoxx Europe 600 index has gained 6% this year, more than double America’s S&P 500.

A turning point came in March when German chancellor Friedrich Merz pledged to rip up the fiscal rules that have held back the continent’s largest economy since the Merkel era. The new government plans to borrow €500 billion to improve Germany’s creaking infrastructure, in addition to easing rules that have constrained defence spending. Berlin’s “astonishing reversal of fiscal policy” was greeted with elation, says John Authers on Bloomberg.

Falling interest rates are another tailwind. At 2%, borrowing costs in the euro area are already much cheaper than in the US, where they are still more than 4%, and with inflation falling below the 2% target last month, there is scope for more monetary stimulus. As the 2022 gas-price spike fades, an older truth is reasserting itself: structurally, the eurozone is less prone to inflation than the US or Britain. Banks have been surprise outperformers this year, with the iShares MSCI Europe financials index surging a third in dollar terms, says Craig Mellow in Barron’s. European banks languished during the long stagnation of the 2010s, which brought economic weakness and rock-bottom interest rates. Now they are better capitalised, while the risk posed by non-performing loans has diminished. And at roughly book value, the continent’s banks still trade at just half the level of their US peers.

France lags behind

Europe’s rally is proving uneven. France’s CAC 40 is barely beating the US index this year, lagging far behind 17% gains in Germany and 15% in Italy. Banks represent a modest 11% of the Parisian bourse’s value, compared with 46% in Milan, leaving Italian investors to reap the rewards of the banking boom, says Corentin Chappron in Les Echos. The CAC is instead heavily exposed to the luxury industry, which is struggling as sales slow down in key Chinese and US markets. Germany has its own problems in the form of a heavy weighting towards the structurally challenged car industry, but that weak spot has been forgotten as the German government starts to spend freely, which should open the way to higher growth in Europe’s largest economy. France is having no such luck. A year after Emmanuel Macron’s snap election call resulted in a hung parliament, the country remains beset by “persistent political uncertainty”.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Investment trust corporate activity continues as the UK’s two largest European investment trusts propose a merger.

Fidelity European Trust (LON:FEV), the largest UK investment trust to focus on the European market, has today announced a proposed merger with the second-largest, Henderson European Trust (LON:HET). The two trusts have market caps of £1.64 billion and £587.3 million respectively, as of close of trading on 18 June – making them the largest European investment trusts in the UK by this metric.

On the morning of 19 June, as the proposed merger was announced, shares in Henderson European Trust gained 3.2% while shares in Fidelity European Trust fell 0.6%.

“The Board of Fidelity European Trust believes this is an exciting opportunity, with compelling benefits for both sets of shareholders, to create the ‘go to trust’ for investing in Europe,” said Davina Walter, chair of Fidelity European Trust. “The proposals will result in the company being well-positioned to continue to deliver attractive returns, with new and existing shareholders benefitting from a reduced management fee and lower ongoing costs ratio.”

The merger follows the resignation of HET’s co-portfolio managers Tom O'Hara and Jamie Ross in February, with both moving to Swiss asset manager GAM Investors.

“The sudden departure of the company’s two co-portfolio managers, together with our subsequent engagement with shareholders, prompted the Board to undertake a comprehensive review aimed at maximising value for all shareholders over the long-term,” said Vicky Hastings, chair of Henderson European Trust. “Following a full and thorough process, the Board concluded that a combination with FEV represents the best outcome for our shareholders.”

How will the merged European investment trust work?

Should the proposals be approved by both investment trusts’ shareholders, HET will be wound up in order to create an enlarged FEV.

That enlarged trust would have net assets of £2.1 billion (based on 17 June 2025 assets. Shareholders would benefit from a reduced OCR and a lower tiered management rearrangement.

“This will create a larger, more liquid, and lower cost vehicle that will benefit all shareholders,” said Claire Dwyer, head of investment companies at Fidelity International. “We are pleased to manage the ‘flagship’ investment trust for European equities, with unparalleled scale and a proven investment approach.”

HET’s shareholders would have the option to rollover into FEV, or to cash in their shares. The cash option is limited to 33.3%.

Is now a good time to invest in European investment trusts?

US stocks have dominated the investing world for much of the last decade, and investment trusts could be a great means of accessing undervalued European stocks.

“Europe has some of the world’s most innovative and global leading companies,” said Marcel Stötzel, co-portfolio manager of FEV. “It continues to prove a fertile hunting ground for stock pickers like us.”

There are other macroeconomic tailwinds that could lift European stocks, particularly those in the defence sector, which have already seen large gains on expectations of increased European defence spending. This comes at a time when the still-uncertain tariff regime threatens to damage the US economy, making Europe a more appealing prospect by comparison.

As of close on 18 June, FEV traded on a discount to net asset value (NAV) of 2.77%, while HET’s discount to NAV was 8.09%.

FEV invests predominantly in continental European equities although up to 20% of its assets may be invested elsewhere. Its stock-picking approach targets companies that can increase their dividends over a three- to five-year time horizon.

“Our investment style focuses on finding companies with good prospects for cash generation and dividend growth over the longer-term, at attractive valuations, with positioning driven by opportunities at the individual stock level rather than macro developments,” added Stötzel.

Andrew van Sickle: Shall we start with an overview of your fund?

Daniel Avigad: The TM Lansdowne European Special Situations Fund is a long-only, mid- to large cap-focused Europe ex-UK fund. We concentrate on key catalysts that can shape markets, such as regulatory changes and technological disruption. We’re not publicly activist, but privately active, seeking to engage with management. The fund has almost quadrupled since late 2009, outperforming the MSCI Europe ex-UK index.

Andrew van Sickle: Moving now to the big picture, we have heard a great deal about the end of US exceptionalism and the Great Rotation towards Europe and other markets. The US market has bounced back, but there is presumably more mileage in Europe, isn’t there?

Daniel Avigad: The opportunity in Europe is that stocks are cheap enough that if investors become confident that the continent is determined to tackle its strategic structural problems, then there is plenty of upside. At present, it looks as though things certainly won’t get worse, and small steps might be taken to improve matters, which is promising given how skewed the global allocation of savings is towards the US.

Adjusted for sectoral composition, Europe is about 20% cheaper than America. The US is expensive relative to its history, and Europe isn’t. There are few asset classes meeting that description today.

Andrew van Sickle: Europe is often dismissed as “old economy”, while the US is charging ahead with technology.

Daniel Avigad: Yes, financials are especially prominent in Europe. However, over the years, things have improved; there are now more high-quality companies in the index. It’s not a case of five names representing 25% of the market, as in the US, but you could say that five names now represent 10%.

Andrew van Sickle: Coming back to the structural problems, will anything change?

Daniel Avigad: Three exogenous forces are making it more probable that we are going to see more changes than at any time in the last two decades. The bond market is the key one. Some countries in Europe are on an unsustainable public-debt trajectory, and it looks as though change is going to be imposed on them. At some stage, they just won’t be able to borrow to spend more. We see signs of that in bond markets every so often, and are keeping an eye on France in this regard.

The basic problem is that political time horizons are short and the pay-off from investment is long-term. This militates against sustainable growth. Markets will be understanding if a government is borrowing to invest, but often they borrow to finance more day-to-day spending compelled by pressure from lobby groups or trade unions.

Andrew van Sickle: What’s the second exogenous force?

Daniel Avigad: Geopolitics. Both the US and China are trying to become more self-sufficient, and Donald Trump is putting Europe under pressure to become more self-sufficient too.

A third force for change is internal politics. Politics has fragmented, with the extremes on the left and right becoming more powerful and the centre collapsing. The legacy parties will have to review their policies and make changes.

Andrew van Sickle: So what happens next?

Daniel Avigad: Firstly, Europe will have to reprioritise growth. There are three subcategories here: the regulatory system, notably planning; the financial industry, which is upstream of everything; and the way we interact with the environment.

Andrew van Sickle: One thing that strikes me about Europe, and the UK, is how the overcomplicated planning system hampers growth; remember the fuss about a £100 million tunnel for bats as part of HS2. In Germany and Austria, there is more of a discussion now on tackling that sort of thing. Similarly, the regulation that proliferated after the financial crisis to pre-empt another one has meant that companies spend ages on administration, not work.

Daniel Avigad: The basic question is: are we trying to manage risk absolutely, or relatively? The answer must be the latter, as the cost of not doing anything is a risk in itself – you forfeit potential, and other economies are taking action. If we unblock some of the regulatory hurdles, growth will tick up, encouraging more investment, thus hopefully starting a virtuous circle.

Then there’s defence expenditure. I hear that at next month’s Nato summit, the organisation is likely to ask for countries to spend 3.5% of GDP on defence, with another 1.5% on associated investments such as infrastructure – roads and rail. Not every country will manage that, and of course, it depends on the bond markets. Should we see appetite diminish to fund incremental investment, then it’s going to be a choice between guns or butter.

On the subject of infrastructure, digital high-speed broadband is crucial, underpinning growth in every industry. To afford that, because it is highly capital-intensive, telecoms companies need scale. Scale comes from having fewer overlapping networks and fewer competitors. So Europe needs consolidation in the telecoms sector. Most major continents or major economies only have three telecoms firms; in Europe, there are still around 85. The UK is leading the way: its four telecoms players have just become three.

To me, it is an economic inevitability that consolidation will occur, but we haven’t seen a catalyst yet because there have been misaligned incentives; for instance, governments have been reliant on spectrum auctions. They also find job losses politically unpalatable, even if they do improve a big national telecoms player’s long-term health. Perhaps this time will be different.

Andrew van Sickle: What is the regulatory set-up in Brussels? The previous competition commissioner, Margrethe Vestager, was known as a liberaliser, but since December 2024, there has been a new commissioner.

Daniel Avigad: Yes, the question is how the new competition commissioner, Spain’s Teresa Ribera, will interpret the law. A Spanish Socialist, she leans left while the overall commission is more centre-right than its predecessor. Within a year or so, major players are likely to test the regulatory water by proposing mergers, so we’ll soon see.

Andrew van Sickle: Let’s delve into structural reforms a bit more. Some European countries have already made great strides. During the euro crisis there was all this talk about the south being starved to death by spending cuts and debt-relief packages, but that obscured some useful changes on the supply side, didn’t it?

Daniel Avigad: Yes. Labour-market flexibility was a key area of reform: the right to hire and fire, for instance. Governments also revisited rules governing thresholds of support in trade unions before negotiations can be entered into with management. The idea was to make the environment business-friendlier to attract foreign investment. Major state-run companies in the utilities and telecoms sectors were privatised, which freed up the economy to a degree. Pension ages were increased, which was a necessity.

So all in all, it wasn’t simply a case of slashing spending. It was about implementing reforms to boost productivity and reduce unproductive spending. Studies on the deregulation in southern Europe suggested that the measured boosted GDP by 2%-3% between 2012 and 2017.

Andrew van Sickle: Next on the agenda, then, are structural reforms in the core of the eurozone. What’s on the to-do list? For instance, it always seems to me that the single-market project got stuck at services; there has been very little integration in that area.

Daniel Avigad: Yes, there are several areas where it would benefit Europe to act more cohesively, as the recent report by Mario Draghi made clear. Capital markets are underdeveloped. The proportion of capital intermediated by banks in Europe is three times higher than in the US: the corporate bond market is too small and fragmented. Issuing public debt at the European level would certainly show that Europe was serious about change.

A continent-wide bank-deposit scheme would be helpful, and there needs to be cross-border consolidation of the banking scene. Let’s see how German politicians respond to UniCredit’s desire to buy Commerzbank. On the regulatory front, Europe should revisit its cumbersome GDPR data laws.

Andrew van Sickle: Let’s now look in more detail at your investment strategy and how you find interesting stocks.

Daniel Avigad: I look at industries’ capital cycles, the flow of money in and out of them. We have two opportunity sets, demand and supply. In the former case, demand for a product outstrips supply, leading to pricing power and growth. With respect to supply, the opportunity arises later in the capital cycle when there’s too much capacity in an industry and you get consolidation, bolstering profitability for everyone. Both opportunities are a result of the mismatch between demand and supply.

A good example on the demand side is EssilorLuxottica. It is the global leader in eyewear, which bodes well as populations age and screen time increases, driving greater interest in eye health. On the supply side, Tele2, our top holding, is the second-biggest telecoms group in Sweden. It should profit as the market consolidates from four to three players. It’s cheap and insulated from the economic cycle.

The fund’s biggest sector is materials (essentially chemicals and building materials), worth a fifth of the portfolio. One major stock in this sector is Saint-Gobain, a producer of construction materials. It should benefit if investments in infrastructure rise as the German debt brake is released.

Finally, we also have a relatively heavy weighting in financials, as we expect consolidation in the sector. In Germany, in particular, the industry is oversupplied, prompting local banks to take risks overseas to secure profits. Hence, all that dabbling in US derivatives in the run-up to the financial crisis.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Markets have been spooked by further tariff announcements from US president Donald Trump, this time focusing on the car industry.

Trump announced a 25% levy on cars and automobile parts coming into the US, issuing a presidential proclamation on Wednesday, 26 March. The measures will kick in from Thursday, 3 April.

Mexico is the biggest importer of autos into the US, followed by South Korea, Japan, Canada and Germany. US car manufacturers will also be hit by the tariffs, given the cross-border nature of their production lines.

Trump justified the tariffs by referencing a 2019 investigation from the commerce department, which found that “excessive” automobile imports threatened US national security.

The Trump administration’s argument is that the defence sector benefits from technological innovations in the autos sector. However, critics will point out that this has become a strategic move from the Trump administration.

By citing national security concerns, Trump is able to bypass Congress and impose tariffs under Section 232 of the Trade Expansion Act of 1962.

Trump has previously cited fentanyl trafficking and illegal immigration as reasons for imposing tariffs, including on countries like Canada.

In reality, there is very little fentanyl crossing the border from Canada into the United States. Government figures cited by CNN suggest just 0.2% of all fentanyl seized last year was found at the Canadian border.

Auto stocks have fallen on the news. Japanese carmaker Toyota closed 2.8% lower on Thursday, while South Korea’s Hyundai shed 4.3%.

European auto stocks also felt the effects when markets opened this morning. “Mercedes Benz fell the most among German automotive stocks, with shares plunging by more than 4% in early trading before rebounding to trade down 3% around midday,” Morningstar writes.

“Volkswagen traded 1.3% lower with BMW down 1.8% and Porsche down 3.6%. Stellantis declined 3.8% while France’s Renault, which has minimal exposure to the US market, bucked the trend and traded slightly higher.”

American auto manufacturers have also opened lower today.

Will auto tariffs hurt US businesses and consumers?

Trump has said tariffs will support US growth and bring jobs and investment into the country, but the reality is quite different. US car manufacturers are actually very worried.

Most US car companies have plants in Mexico and Canada, and parts can cross the northern and southern borders several times during the assembly process.

Trump threatened Mexico and Canada with universal tariffs earlier this month, but wide-ranging exemptions were later granted under the US-Mexico-Canada trade agreement (USMCA), offering car companies a reprieve. This doesn’t seem to apply this time.

All Trump has said so far is that importers can submit documentation to the commerce secretary outlining the amount of US content in each model imported into the US.

Parts that are “wholly obtained, produced entirely, or substantially transformed” in the United States may be eligible for a tariff exemption, but the remainder of the product (any “non-US content”) will be slapped with the 25% tariff.

This is bad news for the US auto industry. Analysis from consultancy Anderson Economic Group, conducted earlier this year, found that tariffs on Mexico and China could push new car prices up by between $4,000 and $10,000.

Take General Motors. Four of its plants are in Mexico and another four are in Canada. Looking at just a couple of the company’s business lines helps bring the scale of the tariff disruption to life.

For example, General Motors is heavily reliant on its Ramos Arizpe plant in Mexico for its transition to electric vehicles, according to Car and Driver’s Caleb Miller.

Meanwhile, the production of Chevrolet’s bestselling model (Chevrolet is owned by General Motors) is split between several plants, including ones in Mexico (Silao) and Canada (Oshawa).

Stellantis and Ford also have part of their production line in Mexico, Canada or both. These companies won’t just be hit by Trump’s tariffs, but also by any retaliatory tariffs that targeted countries decide to impose.

Of course, the long-term ambition for Trump’s administration is that companies move their manufacturing onto American soil – but the reality is that this process is costly and slow.

“With enormous up-front costs… a company could only consider this if there was clear certainty that the policy would be permanent, rather than lasting only the term of the president,” said Lindsay James, investment strategist at wealth management firm Quilter.

“Whilst tax incentives have been suggested, nothing has yet passed Congress. Whether companies have that conviction will be down to their individual appraisals, but in the short term, there is little protection from a move that will have enormous collateral damage.”

European stock markets have outperformed their US counterparts in the opening months of 2025.

With US stocks and indices having been mainstays among the most popular stocks over recent years, its constituents – particularly the big tech ‘Magnificent Seven’ stocks – have seen their valuations stretched further and further.

Is the correction underway, and could European stock markets displace their US counterparts?“

The European stock market has been on a strong run, even as recent tariff talks have led to a pullback in some global markets,” said Lale Akoner, global market analyst at eToro.

“As policy uncertainty increases, the most speculative parts of the market (expensive momentum assets) tend to be the first to correct, underscoring the importance of geographic diversification beyond the US.”

As Merryn Somerset Webb recently wrote for MoneyWeek, European stocks are cheap, and with governments looking for ways to unlock funds for increased defence spending, the continent’s productivity could be on the rise.

How long might the rally last, though – and what are the best ways for investors to access Europe’s resurgent stock markets?

What are the main European stock markets?

The largest pan-European stock market is the Euronext exchange, which is based in Amsterdam but has its operational centre in Paris. Euronext covers the Amsterdam, Brussels, Dublin, Lisbon, Milan, Oslo and Paris marketplaces.

The main European stock market indices are the Stoxx indices (Stoxx 50 and Stoxx 600), which track stocks from 17 countries across the Eurozone. There is also the Euronext 100 which tracks the 100 largest and most liquid stocks traded on Euronext.

The national stock markets that are most commonly tracked include Germany’s DAX and France’s CAC. Their major indices are the DAX 40 and CAC-40, which track the forty largest stocks in each respective country.

Then there is the FTSE 100, which tracks the 100 largest UK stocks. It depends largely on context whether or not these would be included among European stocks. Generally, they aren’t associated with European stock markets, but in certain trends such as the recent shift towards defence stocks, it makes sense to consider UK and European stocks alongside one another.

Why are European stock markets outperforming the US?

As Somerset Webb points out, US valuations have been over-stretched for some time, while European stocks have been persistently cheap.

Cheap doesn’t necessarily mean undervalued – for years, they have looked like a value trap – but it does mean there is room for upside, should conditions or productivity improve. Both look like they are.

The ECB cut interest rates on 6 March. Granted, that was partly driven by the economic uncertainty the continent faces in light of the US pulling its military support for Ukraine. However, with that comes the potential for greater European spending on defence.

European companies have upped their game. “The Q4 earnings season exceeded expectations, reviving EPS growth after a period of stagnation,” says Akoner.

“Banks have led the way, with names like Santander, Intesa, and BBVA accounting for the bulk of the upside surprises. The tech sector (ASML, Infineon) has also performed well, though luxury giant LVMH and pharmaceutical leader Sanofi have been notable underperformers.”

Conversely, the overvaluation of US stocks means there is little upside and plenty of downside potential.

The Federal Reserve (Fed) signalled last month that its rate-cutting cycle is done for the time being. While the language around the ECB’s March decision hints that the same could now be true in Europe, it post-dates the Fed’s apparent pause, and leaves Eurozone interest rates substantially lower than those in the US.

Fears of a ‘Trumpcession’ – a self-inflicted recession off the back of the trade war that Trump is intent on waging – create a gloomy outlook for the US economy.

European investors also appear to have soured on the US. The FT cites Morningstar data showing that European-domiciled ETFs investing in US equities experienced $510 million in outflows in the month to 24 February, despite total European ETF flows rising to $35.3 billion.

Europeans aren’t just going off US stocks, but also US products. Trump has previously stated that he might use tariffs to incentivise Europeans to buy more US cars. So far, his administration seems to have had the opposite effect: sales of Tesla cars in Europe have fallen 45%, contributing to Tesla’s share price falling more than 30% so far this year.

Can the European stock market rally last?

The question of course is whether the European stock market rally is a short term response to the economic conditions that have materialised at the start of 2025, or reflective of a longer-lasting trend.

To some extent that will depend on how the macro situation unfolds. It’s far from clear how far Trump is really prepared to push the inflationary risks of his tariffs, and how damaging they might be to Europe in particular.

A peace deal between Russia and Ukraine – whatever the terms – would change the global economic outlook significantly. This would likely be to Europe’s benefit, but it could also reinvigorate US stocks.

As things stand, though, the evidence doesn’t point to Europe’s rally dwindling out. The DAX 40 is making new highs, but as Akoner highlights, 74% of its constituents are trading above their 200-day moving average, compared to 96% at its previous market tops, “suggesting that momentum, while positive, is not extreme”.

However, she adds that a failure to expand profit margins in 2025 could cause the rally to “lose steam”.

Automakers and luxury goods firms stand to lose most from aggressive US tariffs, “while industries like mining and beverages could also see headwinds if trade relations worsen”, says Akoner.

Which European funds can I buy?

There are plenty of ways to access European stock markets, but one way of gaining quick exposure to a broad set of the continent’s market is to buy a fund that tracks European equities.

A broad-based tracker fund for European stocks could be the iShares Core MSCI Europe UCITS ETF (LON:0A3G). This tracks an index of large-, mid- and small-cap European equities.

For a focus on some of the largest European stocks, investors can consider an ETF like the Amundi Stoxx Europe 50 UCITS ETF (LON:0XA5). This tracks the performance of the Stoxx 50 index, providing exposure to the 50 largest stocks in the Eurozone.

Or at the other end of the spectrum, the European Smaller Companies Trust (LON:ESCT) is an investment trust that invests in small- and medium-sized businesses based mainly in Western Europe, excluding the UK. Mostly, it invests in stocks with a market cap between £1 billion and £3 billion.

Europe finds itself “in the midst of a perfect storm”, says The Economist. Growth faces “stiff headwinds” and electorates are “routinely tossing their leaders overboard”. Donald Trump is planning tariffs. Europe’s catalogue of problems is long, says Simon Nixon in the Financial Times. Growth has “stalled”, regulation is “burdensome”, energy prices are “high” and manufacturing is under pressure from China.

Yet with so much pessimism around, there is a “very low bar” for positive surprises that could boost stocks. So what might go right? Unexpectedly large interest-rate cuts by the European Central Bank (ECB) would help. On the political front, an end to the war in Ukraine could improve sentiment. Finally, German elites are slowly coming around to the idea that the country must reform its self-defeating “debt brake”, which has long been an obstacle to higher growth.

A large Chinese stimulus in 2025 would also boost European equities, says Frédérique Carrier of RBC Wealth Management. The Middle Kingdom is a “key export destination” for the continent’s goods.

A strong start to 2025 for European stocks

Economic sentiment is “on the floor” in Germany, yet European stocks have enjoyed a surprisingly strong start to the year, says John Authers on Bloomberg. The DAX index is up 7% already this year, with France’s CAC 40 not far behind. Bank of America’s latest monthly survey shows global fund managers have raised their “European weighting… by the most in any month since 2015”. It seems the continent’s stocks have simply become too cheap to ignore, giving a substantial “margin of safety” for investors. As Andrew Lapthorne of Société Générale notes, MSCI Europe is trading at a record 40% discount to US stocks on a forward price/earnings basis.

Germany has been in recession for the past two years, yet the country’s stocks have been the best-performing major European market over that period, says Pierre Briançon for Breakingviews. The blue chips of the DAX are large multinationals geared to global growth. Only a fifth of the DAX’s sales actually originate in the home German market, with 24% from America and 18% from China.

But a looming tariff war with Trump could soon choke off that release valve. Escaping Germany’s “grim economic reality” is becoming harder and harder for investors. DAX earnings look to have fallen by 9% for the full year 2024, according to a note from Deutsche Bank, with declines driven mainly by plummeting car-industry earnings.

Nevertheless, earnings look set to enjoy a “strong recovery” in 2025, with 11% year-on-year growth powered by technology, industrial and financial shares. Analysts’ year-end target for the DAX is 23,000 points, a further 7% gain from the current level.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Europe’s “Franco-German engine” is “kaput”, say Jon Henley and Deborah Cole in The Observer. French president Emmanuel Macron has just appointed his fourth prime minister of the year following the collapse of Michel Barnier’s short-lived administration. Across the Rhine, Olaf Scholz’s fractious coalition lost a no-confidence vote, leaving Germany heading for early elections.

“We are quite pessimistic about the economic and financial outlook for the eurozone,” says Hubert de Barochez of Capital Economics. Manufacturing remains under “intense pressure” amid tepid Chinese demand. Donald Trump’s tariff threats only add to the uncertainty – German stocks were “among the worst affected in 2018” during Trump’s first trade war. An economic turnaround requires strong government action, but in Paris and Berlin, executives are mired in dysfunction.

It’s not all bad, says The Economist. “Peripheral” countries such as Greece and Ireland were hit hard by the eurozone crisis, but following painful reforms, they are now booming. Spain is “on course to be the best-performing, rich-world economy of 2024”, with economic growth and job creation beating even the US. The local Ibex 35 share index is up 15% this year. Spain is increasingly competitive in consulting and technology. That’s a reminder that, in a modern economy, “it pays to focus on services and not fetishise manufacturing”.

What's the outlook for Europe's economy?

The Stoxx Europe 600 index is up 7% this year, leaving European shares set to underperform the US “by the most in at least 25 years”, says Naomi Rovnick for Reuters. Yet some traders think we have reached “peak pessimism”. France’s CAC 40, down 2% this year, has not recovered from Macron’s decision to call early elections in June. Parisian fashion houses have suffered as Chinese shoppers tighten their belts. And for all the gloom about German carmakers, Frankfurt’s DAX index is up more than a fifth in 2024, says Étienne Goetz in Les Echos. This partly reflects the fact that, unlike most indexes, the DAX is a total return index (it includes dividends), but underlying performance is nevertheless robust. These days, 11% of German exports go to the US, far ahead of the 6% that go to China. Germany hasn’t totally missed out on the tech rally either, with local software giant SAP surging 73% in 2024.

Surprisingly, Germany has been “one of the best-performing stock markets in the world” since Donald Trump’s election victory, gaining more than 6% in a matter of weeks, says Katie Martin in the Financial Times. That may reflect the fact that a weakening euro will help the country’s exporters, or market bets that Germany’s next government is likely to be more effective than the outgoing Scholz administration.

More fundamentally, it is a reminder that European multinationals earn much of their revenue globally. Investors tend to overreact to “minor episodes of political instability” on the continent. Given beaten-up valuations, any “outbreak of political tranquillity in Germany and France” could set off a relief rally next year.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

European stocks have struggled this year thanks to the continent’s economic troubles. European equities are now trading at the most significant discount to their US counterparts since at least 2003. The 12-month price-to-earnings (p/e) multiple of the MSCI Eurozone index is 60% of the MSCI US index, compared with its 20-year median of about 80%.

Some of this gap is warranted. Europe has registered anaemic growth since the financial crisis and, since Covid, the economy has ground to a halt. High energy costs and political chaos have hit the core economies.

According to the International Monetary Fund, Europe’s ageing workforce, low productivity growth and “lack of business dynamism” will reduce the continent’s GDP growth rate to just 1.45% per annum over the rest of the decade, compared with 2.3% for the US. JPMorgan estimates that eurozone GDP is expected to fall below 1% next year – without considering the impact of any changes to global trade induced by Donald Trump.

Earnings at listed European companies will stagnate in 2025 for the second year in a row. Tariffs are the wild card. Trump has promised to bring in tariffs on goods imported from Canada, Mexico and China on his first day in office. JPMorgan has put the cost of Trump’s tariffs the first time round (2018) at 1% of euro-area GDP over two years. This time it could amount to as much as 2% if Trump follows through with his plans to hit European imports with tariffs of 10% to 20%. Germany and Italy would be the most vulnerable in this worst-case scenario.

Considering the eurozone’s economic outlook, European equities, in aggregate, deserve to trade at a discount to their US peers. However, uncertainty is creating some opportunities as investors indiscriminately dump European stocks.

Are European equities undervalued?

Europe might not be home to many technology giants but it still offers some of the world’s most successful businesses in their respective fields. The continent’s demographic challenges will also be a tailwind for key sectors. Then there’s the defence sector. Russia’s war against Ukraine has spurred defence spending in Europe, a trend that seems set to continue for many years.

Considering these factors, the iShares MSCI Europe Health Care Sector Ucits exchange-traded fund, or ETF (LSE: ESIH); HANetf’s Future of Defence Ucits ETF (LSE: NATO); and the iShares MSCI Europe Energy Sector Ucits ETF (LSE: ESIE) look worthy of further research. They are regional thematic plays on government spending and the continent’s ageing workforce.

An alternative is JPMorgan’s Europe Research Enhanced Index Equity (ESG) Ucits ETF (LSE: JERE). This ETF builds on the idea of passive index investing by incorporating research from analysts at JPMorgan. It overweights positions to securities with “the highest potential to outperform” while underweighting those considered most overvalued.

The results of this approach have been impressive. Since the fund’s launch in October 2018, it has returned 9.2% annually, compared with 8% for the benchmark (the MSCI Europe Index). The fund is overweight in the UK, at 25.4% of assets compared to 22.6% for the benchmark. It’s also overweight energy names, such as Shell. It’s overweight the Dutch semi-conductor equipment manufacturer ASML but underweight another of the continent’s tech champions, SAP, which gives us a real insight into where the team sees value.

There is no guarantee that Europe’s equity markets will rebound or economic growth will pick up, and the situation could get worse for the region. However, considering the valuation, there’s a lot of potential disappointment already baked in here, and if growth does return, the snap-back could be substantial. With an expense ratio of just 0.25%, it’s a cheap way to build exposure to cheap European markets and avoid some less exciting opportunities.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

France’s CAC 40 share index has fallen 9% from a mid-May high. Paris has underperformed wider European markets, with the Euro Stoxx 50 index up almost 9% for the year-to-date. But for all the talk of European stagnation, “equities in Europe have delivered nearly as much” as US ones over the past few years, says Hubert de Barochez for Capital Economics. 

While US valuations have risen faster, European ones have kept pace thanks to improved earnings expectations and higher dividend payments. French stocks even outperformed US ones between the end of 2021 and June this year, before Macron’s snap election sank the Paris bourse. All is not lost. When America’s “AI bubble” eventually bursts, Europe could enjoy a renewed period of outperformance. Eurozone valuations are close to “historic lows” relative to frothy US stocks, say Oliver Girakhou and Carly Brewster of asset manager Robeco. 

On a price-to-earnings basis, the MSCI Eurozone index has been trading at discounts to America that are comparable to dotcom or euro-crisis lows. Lower valuations provide a “firm floor” for stocks in the case of bad news. While Europe’s own growth prospects are poor, the region’s stocks are unusually multinational: 60% of MSCI Europe revenue originates from outside the eurozone. Deutsche Bank estimates that a mere 18% of Dax 40 revenue comes from Germany, less than the 22% from the US.

What is the outlook for European stocks? 

Investors’ perception of Europe has been coloured by a 15-year period of poor post-financial-crisis performance, says Oliver Collin of Invesco. Much of the drag came from weakness in once dominant banking stocks, but balance sheets have been fixed and the banks are today paying “handsome dividends” once more. “History suggests it would only take a small positive shift in expectations” to deliver “an outsized share price performance”.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

European stock markets ought to be soaring. The “precipitous sell-off in tech stocks” that started last month in America should have been good news for Europe, says Craig Mellow in Barron’s. 

The US stock “rotation” has seen investors turn to smaller, more “value-oriented” American firms. Europe has similar value appeal. The pan-European Stoxx 600 index trades on a price/earnings ratio of 15, a large discount to the US S&P 500’s 25. Even long-suffering European banks seem finally to have turned the corner after a dismal decade.

Euro stocks affected by politics and profits

Yet investors are reluctant to take the plunge. In France, a fractured parliament has yet to yield a new government, while on the other side of the Rhine, “Olaf Scholz’s fractious coalition government” is “limping” on. Meanwhile, earnings from European companies have been “less than enchanting”, says Ipek Ozkardeskaya of Swissquote Bank. That has prevented the continent from “benefiting from the sector rotation in the US”. 

European companies entered the latest earnings season with little room to disappoint because of “overly bullish” forecasts, Lex notes in the Financial Times. The Stoxx 600 has been trading close to record highs for much of this year, but some of the key drivers of that boom are starting to sag. Cyclical sectors – notably luxury goods – have begun to “wilt” as consumers rein in spending. That is putting pressure on profit margins. Investors have been “unforgiving” of late, quickly selling off any company whose results disappoint. 

The Stoxx 600 has dropped by 5% over the past week amid the global stock rout, though it remains up 2% for the year to date. French luxury giant LVMH has been playing a prominent role in the Paris Olympics, says Holly Thomas in The Times. Medal bearers are “sporting custom-designed Louis Vuitton outfits”. But beyond luxury, the continent has other global champions who are worthy of gold medals. 

Jordy Hermanns of Aegon Asset Management’s list of “Eurostars” also includes pharmaceuticals (Denmark’s Novo Nordisk), tech (Dutch firms ASML and Adyen) and green engineering (France’s Schneider Electric). Unlike America’s Silicon Valley-focused mega-caps, Europe’s leading firms “represent a spread of sectors” and earn much of their revenue abroad, making them “a critical component of any well-diversified global investment portfolio”. 

The European Central Bank is cutting interest rates ahead of the US Fed, say Lazard analysts. The turn in the interest-rate cycle will put Europe’s yield advantage into “sharper relief” – the MSCI Europe index pays 3.5%, compared with a yield of 1.5% in America. That is “near Europe’s highest-ever dividend yield premium compared with the US.”

Related articles

• Why now is a good time to invest in European markets
• Overlooked European stocks that offer income and growth potential
• Top-quality, growing European stocks are selling at enticing valuations
• Three European stocks set for sustainable profit growth

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

We invest in attractively valued companies with the potential for positive change. This typically means investing in overlooked stocks where there is little or no value ascribed to any recovery potential. The market is often slow to recognise change in out-of-favour stocks, which gives us time to undertake our due diligence and build conviction in the positive change thesis. It can be centred around either internal or external change; ideally, a combination of both. If things improve as we expect, there should be significant upside as the consensus view changes and new investors buy into the story.

Overlooked European stocks

Imperial Brands (LSE: IMB) has undertaken a significant turnaround under new management, improving the execution of its strategy and strengthening its balance sheet. It is catching up with the competition in developing a range of less harmful next-generation products. Our investment thesis is two-pronged. We can make very strong returns simply from its generous dividends and share buybacks. Imperial is returning the equivalent of 16% of its market value to shareholders this year alone. 

However, if regulations governing next-generation products do tighten, as recent signs in the UK and, importantly, in the US suggest, then these categories can grow much faster and be far more profitable. Over time this could be transformational, as a much larger proportion of the firm’s products will boast far greater longevity than the current tobacco business. 

DCC (LSE: DCC) is a global distributor of liquefied petroleum gas (LPG) and oil, as well as medical and technology products. The group has proved its ability to build scale in fragmented sectors through a disciplined approach to mergers and acquisitions. It boasts a high-quality business, a strong balance sheet and a long record of generating attractive returns. 

However, its shares are trading on multiples usually seen at the trough of a cycle owing to investors’ concerns that its energy division will come under significant pressure as demand for fossil fuels declines. We expect the decline in demand to be slower than the market anticipates and offset by higher margins thanks to the consolidated nature of the market. Additionally, we believe that the company’s ability to distribute alternative lower-carbon-intensive energy sources to customers cheaply through its existing infrastructure is underappreciated. It should help the group sustain or even improve high returns.

Banks have been another unloved sector since the global financial crisis. However, more stringent regulatory oversight has forced banks to increase capital ratios, boost funding levels and refrain from riskier lending. Higher interest rates have allowed them to improve their profitability significantly. 

One of our largest holdings in the sector is Standard Chartered (LSE: STAN), a diversified banking group with a focus on emerging markets, especially Asia. Management is focusing on better cost control. Revenues should be supported by the group’s broad sensitivity to global interest rates and the structural growth of its wealth and financial markets divisions, which account for 40% of revenues. A strong start to 2024 and a plan to buy back a significant portion of its shares (around 9%) gives this story credibility.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

“After a decade of stunning performance” on Wall Street, global investors are feeling uneasy about the dominance of US stocks in their portfolios, says Sharon Bell in the Financial Times. European equities could offer better value. The energy shock has made the last few years a tricky period for European markets, opening a large transatlantic valuation gap. US shares trade on a price/earnings ratio of over 21, compared with 14 in Europe and around 12 in the UK. 

European stocks have at least managed to hold their own this year, says Bastien Bouchaud in Les Echos. The Euro Stoxx 50 index has gained nearly 12% so far in 2024, just a smidge behind the S&P 500. Inflation has cooled faster on the “old continent” than in the US, with the European Central Bank poised to start cutting interest rates as early as June. Easier money usually finds its way into financial markets, which will support share valuations.

European markets: rise of the Granolas 

Much as US markets have been driven by the “Magnificent Seven” tech firms, so too a handful of European giants have made the running. Dutch chip specialist ASML has accounted for about a fifth of the Euro Stoxx 50’s gains this year alone. Bank Société Générale has dubbed the outperformers the “Seven Wonders of Europe”, says Jamie Chisholm in MarketWatch. The group includes ASML, pharma group Novo Nordisk, luxury conglomerates LVMH and Hermès, software play SAP and industrials Siemens and Schneider Electric. Many of them also feature in Goldman Sachs’ “Granolas” category, a pan-European grouping of 11 top stocks that also includes UK firms AstraZeneca and GSK. 

The Granolas make up about a quarter of the Stoxx 600 market and contributed 60% of the gain in the year to 1 March, says Michael Fahy in Investors’ Chronicle. The group collectively trades at a roughly 60% valuation premium to the wider European market, but is still on a discount of 30% to the Magnificent Seven. Over three years they’ve broadly “matched the returns of the US tech giants”, but with less volatility. No European firms rise to the trillion-dollar valuations of the biggest US companies, says Jocelyn Jovène for Morningstar. But the Granolas do represent a more diversified grouping than the US tech giants, taking in healthcare, technology and both cyclical and defensive consumer themes. 

European stock markets have transformed over the past decade, says Frédérique Carrier of RBC Wealth Management. No longer the preserve of stodgy banks and telecom groups, today's fast-growing technology, healthcare, industrials and consumer discretionary firms together account for 57% of the MSCI Europe ex-UK index, up from 37% in 2011. “Bloated conglomerates” have slimmed down into leaner operators: return on equity rose from 9.8% in 2011 to 13% last year. Europe may lack the dynamism of the US or emerging economies, but investors often overlook the fact that about 55% of revenue comes from outside Europe. “No longer wan and listless... European equities are emerging from their chrysalis with newfound potential.”

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Recession is “just round the corner” in the eurozone, says Jack Allen-Reynolds of Capital Economics. Weakening business surveys, higher gas prices and tighter monetary policy herald a tough second half.

The Euro Stoxx 50 index of euro-area blue chips has fallen 13% this year. European shares are out of favour with global money managers, says Michael Msika on Bloomberg. Allocations to euro-area equities have hit their lowest level since June 2012. Analysts at UBS think that European stocks are heading for their worst year since 2008.

Bavarian bargains

Still, a rally this summer has left some wondering whether the worst of the sell-off is over. The Euro Stoxx 50 has gained 11% since a low in early July. France’s CAC 40 has outperformed, says Bastien Bouchaud in Les Echos. With Italy facing political turmoil, Germany curbing gas use and the Spanish government hiking taxes, Paris appears a haven of relative “tranquillity”. Luxury fashion houses are raking in cash, with Hermès’ stock up more than 30% this summer. German exports are focused on China and Eastern Europe, while French firms have a more diversified set of clients, says Frederik Ducrozet of Pictet Wealth Management.

With French stocks trading on a cyclically adjusted price/earnings (CAPE) ratio of 20.8 at the start of this quarter, however, the Paris bourse is getting as pricey as one of Hermès’ Birkin handbags. Value hunters should instead consider Germany’s battered industrial base. On a CAPE of 13.9, German stocks are now slightly cheaper than their British counterparts.

At those levels “you’re not paying for good news”, says Matt Burdett of Thornburg Investment Management. Recession risks are arguably priced in. Europe hosts plenty of excellent multinational businesses that will continue to make money overseas even if the local economy slumps.

The trailing price/earnings (p/e) ratio of eurozone equities “has plunged to just under ten, from a peak of over 25 a year ago”, say Claus Vistesen and Melanie Debono of Pantheon Macroeconomics. The region’s stocks “are trading at multiples close to the nadirs during the financial and sovereign debt crises, which were good times to invest in eurozone stocks”. While cheap stocks tend to mean better long-term returns, don’t bet the house on a quick turnaround: a recessionary hit to corporate earnings – which could fall 20% over the next 12 months – is likely to prove “a drag on equity performance” for the rest of 2022 before a rebound next year.

European value shares look especially appealing, says Ben Arnold of Schroders. They “are… trading on lower [p/e ratios] than they were five years ago”, a rarity in developed markets after years of easy money. “Europe is one of the most overlooked ... markets in the world. Perhaps not for long.”

“Europe once again stands at the edge of the precipice, staring into the abyss below,” says Jeremy Warner in The Telegraph. The 2009-2012 eurozone crisis was centred on “tiny” Greece – just think what debt problems in a major economy such as France could do to the single currency.

French prime minister Michel Barnier’s three-month-old minority government has collapsed after being ousted in a vote of no-confidence on 4 December, following which Barnier resigned. Barnier’s “fragile” administration had been trying to close a fiscal deficit of 6.1% of GDP with €60billion in spending cuts and tax hikes, says Liz Alderman in The New York Times.

His plans have drawn the ire of opposition parties, with the far-left and far-right ganging up to vote him down. That leaves president Emmanuel Macron in a bind. France’s legislature is hopelessly divided, and Macron legally can’t call fresh parliamentary elections until June next year. The risk premium, or “spread”, between benchmark French and German government bonds has touched 90 basis points, the highest level in 12 years. In a further humiliation, financial markets have started charging France the same amount as Greece to borrow for a decade.

Talk of a Greek-style crisis is “for the moment... a complete exaggeration”, Éric Heyer of Sciences Po tells the Financial Times. At 2.9%, French ten-year yields are far below the 16% level that Greek bonds hit in 2011. Indeed, French borrowing costs are currently lower than Britain’s. Unlike with Greece, there is no doubt that European institutions will do “whatever it takes” to save France, says Andrew Kenningham of Capital Economics. Crisis-era Greece had a 15% deficit and plunging GDP, compared with a 6% deficit and modest growth in France today. Paris requires a relatively small fiscal tightening to sort out its budget. The problem is not so much economic as political – France seems “unable to give any government a mandate for deficit reduction”, leaving the issue of growing debt to fester.

The real risk for the eurozone will only come if Marine Le Pen’s far-right party takes power in a future election. While Le Pen no longer supports leaving the euro, her party will be “much less committed to cooperating with the EU” to keep the currency bloc functioning smoothly. If things do get out of hand, then expect the European Central Bank (ECB) to deploy its Transmission Protection Instrument (TPI), says Johanna Treeck in Politico. The TPI allows the ECB to buy up government bonds if it thinks bond markets have become “disorderly”. Yet the “bar for such intervention is high” – probably requiring French debt to hit somewhere above 200 basis points of spread over German bunds, compared with today’s 85 points.

What the crisis in France means for Macron

Macron has pledged to appoint a new prime minister within days and vows to stay in office until the end of his term in 2027. Macron has three bad options to resolve the political deadlock, says Pierre Briançon for Breakingviews. He could try to repeat the failed Barnier trick, appointing a “temperate centrist” willing to do budget deals with the far-left or far-right. Alternatively, he could pick a far-left or far-right administration, purely to demonstrate that the populists are also “unable to govern”. Finally, he could conclude that he himself is the problem and resign, plunging France into the uncertainty of a snap presidential election.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Until the end of last week Herbert Diess looked “every inch the modern, global auto titan”, say John Arlidge and Jon Yeomans in The Sunday Times. However, the CEO of Volkswagen was evidently “too brash, too bold and in too much of a hurry for many of the company’s key stakeholders”. VW announced that he had been forced out three years before the end of his contract by a unanimous vote of the carmaker’s supervisory board. The move has upset many institutional shareholders, with analysts calling it “another illustration of dysfunction at VW”.

Diess’s departure was at least partly the result of “a series of public blunders”, says Joe Miller in the Financial Times. These include saying he was “not aware” of detention camps in China’s Xinjiang region and using the insensitive phrase “EBIT macht frei” at a company event. He also gained “notoriety” for his “skirmishes” with VW’s “powerful works council, which controls several seats on the company’s supervisory board”. Unions were particularly “angered” by his suggestion that the group had 30,000 excess staff and his complaints that Tesla employees managed to produce an electric car in just a third of the time it took VW.

Clashes with the workers

Diess’s gaffes and “frequent clashes with powerful worker representatives” may have played a role in his departure, but they were survivable as long as he had “unwavering support” from the billionaire Porsche and Piech family, the majority owners of VW, says Monica Raymunt and Christoph Rauwald on Bloomberg. However, his “key project failures” gradually persuaded the family that “he had to go”. These failures include delays to the “scheduled rollout of important new models, including the electric Porsche Macan SUV” as well as struggles “to muster broader support” to implement a €89bn electric-vehicle (EV) and software strategy.

Still, even his harshest critics acknowledge Diess’ “strategic vision” and his “achievement in transforming VW’s culture for the [EV] age”, say William Boston and Georgi Kantchev in The Wall Street Journal. His emphasis on moving away from fossil fuels “has seen VW’s brands, including Porsche, Audi, Seat... and Bentley develop core electric models with a plan to shift fully to EVs this decade”.

The change at the top “probably won’t derail Volkswagen’s electric vehicle ambitions”, especially since Porsche – under VW’s new CEO Oliver Blume – “has rolled out the successful Taycan model and expects green vehicles to be as profitable as combustion engine cars in two years”.

A “fresh start” may even help Blume persuade the wider company to raise investment in EVs “while improving lacklustre profitability”. But Blume’s appointment could muddy Volkswagen-Porsche’s already complex governance: he will still be in charge of Porsche even though Volkswagen plans to list the luxury brand. If this set-up produces a “greater muddle”, investors “may start to miss... Diess’s gaffes”.

Bridgewater is one of the biggest money managers in the world, and its founder Ray Dalio has been proved right more often than not. It managed to call the sub-prime crisis correctly slightly over a decade ago and it has consistently outperformed the market since then. Even in the ruthlessly competitive world of hedge funds it is a class act, with a long record of success.

When it takes a major position, most of its rivals quite rightly take notice. In the past couple of weeks it has emerged that Bridgewater is targeting a collapse in European stocks. Earlier in the month, it was revealed it had taken a $6.7bn short position against the continent’s largest businesses and only a week later that had grown to more than $10bn.

Fault lines reopen

That is a lot of money to wager on a fall in the market, especially as the major indices have already corrected sharply since the start of the year. Germany’s Dax has fallen by 17% since January, France’s CAC by 16%, and the Euro Stoxx 50 that covers the continent’s biggest companies by 18% (although the FTSE 100 is only off by 2%, mainly because it is so dull). Most people might well think it is time that equity prices bounced back. There are three big reasons why Bridgewater’s bet is going to pay off.

First, Russia’s invasion of Ukraine is turning into a long, brutal war of attrition. There is no sign it is ending any time soon. Sanctions will remain in place for many years to come, hitting exports to Russia. More importantly, Europe is going to have to find a way of living without Russian oil and gas. That might be just about possible, but it will be expensive (the reason we imported it from Russia was because it was relatively cheap).

In Germany, some form of energy rationing now looks a certainty over the coming winter, and if that includes factory closures or shortened working weeks, it will tip the country into recession. Worse, the major European economies will all have to raise defence spending, as well as paying for the arms they are shipping to Ukraine, and sooner or later pay for reconstruction as well. It will take a huge toll on the economy.

Next, inflation is about to reopen the fault lines in the single currency. We already knew from the crisis of 2011 and 2012 that the euro was dysfunctional and open to speculative attacks. European Central Bank chief Mario Draghi just about managed to paper over the cracks with printed money. But now? The reality is that the euro has never faced serious inflation before and is heading into a crisis as the ECB has to choose between controlling prices or bankrupting Italy and Greece. There have already been sharp rises in bond yields in the peripheral countries, and the ECB has promised to come up with a mysterious sounding “stabilisation tool” to control those, although there is not much detail on how it will work yet. The real test will come when interest rates start to rise next month – what happens then is anyone’s guess.

Finally, Europe’s trade deficit is soaring. Whatever their other problems, the major EU economies always managed to run a big trade surplus. That has now switched. The eurozone countries recorded a deficit of €16bn in March, and that is rising all the time. In part that reflects the cost of importing more energy. But it also reflects its declining competitiveness. That deficit will subtract from growth and at the same time put pressure on a currency that has already fallen close to parity with the dollar, but can still go down a lot more. From here on, trade is going to subtract from growth rather than help it – and that is a big change.

True, the British, American and Japanese economies are hardly in great shape either. Inflation is still dangerously high, political leaders don’t have the will to control it, and central banks are still trying to work out what level of interest rates will be needed to stop it running out of control. There will be recessions in most of the major economies. The only real question is how deep they will be. But Bridgewater is right: Europe is the weakest of all the major regions, and its economy is heading into a steep downturn – and its huge bet against Europe will prove very shrewd.

“To conquer without risk is to triumph without glory,” as Pierre Corneille wrote in his classic tragicomedy Le Cid. Thus on Sunday, Emmanuel Macron won the French presidential election without any glory.

The elections themselves have lost their traditional spark and sense of jousting. The final debate between Macron and Marine Le Pen was a debate between technical managers without a grand vision for France. Both want to write cheques that France can’t cash. And this second-round match up was simply what had been anticipated for years, despite brief bursts of speculation that another candidate – Éric Zemmour (far-right), Valérie Pécresse (centrist) or even Jean-Luc Mélenchon (far-left) – might edge out Le Pen.

Still, the elections brought some surprises. First, the anti-establishment parties represented by Melenchon, Zemmour and Le Pen have become mainstream, gathering more than half of voters who are extremely dissatisfied. The causes of their miscontent range from a loss of social identity to dwindling purchasing power, and from heavy taxation to management of the Covid-19 crisis. When I met Marine Le Pen last December in Warsaw, she presented herself more as a classic left-wing candidate than a representative of the right. She left the topic of migration and identity to Zemmour. She vowed to protect the French working class against globalisation and to focus on purchasing power. This was a good intuition, allowing her to be in the second round once again and to increase her share of the vote from 33.9% in 2017 to 41.5% now.

Hence an alternative view of the presidential elections is that three left parties have gathered three-quarters of voters in the first round: Le Pen (23.2%), Melenchon (22%) and Macron (27.9%) – it should not be forgotten that he was finance minister under leftist president François Hollande before creating his own movement to run for president in 2017. Un carnage a trois. Can le déclin français ever be stopped?

Two decades of decline

In the mid 1990s, French industry was able to compete against German industry, while Paris was battling with London to be the financial hub of Europe. But France was unable to reform its social system: wide-ranging strikes and protests in 1995 forced prime minister Alain Juppé to abandon his proposed reforms. Today, social spending represents a record 31% of GDP (the comparable figure for the UK and for the OECD average is around 20%), of which half is represented by pensions. It’s a world record and “a crazy amount of dough”, as Macron pointed out.

The traditional strengths of France – mainly its infrastructure, a few multinational large-cap companies and its agriculture sector, have weakened significantly. The pandemic and recent scandals related to care homes have highlighted the weaknesses of the healthcare system. In education, France has plunged steadily in the OECD’s programme for international student assessment (Pisa) ranking, because the education system promotes equality and rejects selection, which aligns pupils with the weakest. French teachers are reportedly surprised by the relative excellent level of maths among Ukrainian refugees. This does not bode well for the future of the nation. The justice system is short of funds… one could go on. Considering this lack of investments in key sectors, one wonders what the heavy level of taxation is for.

The euro worsens France’s lack of competitiveness, because it is unable to devalue its currency. The euro was tailored for the German economy while the “Club Med” economies (Greece, Italy, Spain, and indeed France) were pacified with excessively low interest rates. The French economy is now in the second league – its industry is struggling to compete with rejuvenated Spain and rising Eastern Europe. Industry represents 16.5% of GDP, even less than in the UK (17% of GDP), despite the fact that the latter is often presented as the country with no remaining industry.

Macron failed to deliver

Back in 2017, Macron consciously aspired to be a “Jupiterian” president – an aloof figure with god-like powers to reform France. An inexperienced parliament voted at his command, approving laws often late at night once most MPs were home. Most ministers remained unknown, except the ones caught in some scandals. But despite promising to be a revolutionary, he turns out to be more of a management consultant, mainly concerned with his image and enjoying his power.

Admittedly, he faced some challenges: the gilets jaunes protest movement, the pandemic (although this allowed him to present himself as a war leader) and now Russia’s invasion of Ukraine. And to be fair, he initially took some good decisions. He maintained the crédit d’impôt pour la compétitivité et l’emploi (CICE), a tax credit to promote competitiveness and employment introduced by his hapless predecessor Hollande. He capped capital gains tax at 30% and reduced corporation tax from 33.3% to 25%. These reforms were highly necessary. Other taxes such as the contribution sociale généralisée (CSG), to fund the welfare system, and green taxes were increased.

Pre-pandemic economic growth was close to 2% per year on average, slightly above its average since 2000. GDP is also expected to recover its pre-pandemic levels this first half of the year. GDP growth this year is expected to be 2.9%, in line with the eurozone, although falling to its long-term trend of 1.4% in 2023. Unemployment decreased from 9.4% to 7.6%. Even now, inflation remains relatively contained compared with the rest of Europe at 4.5% because some energy and electricity prices are capped. Purchasing power – the theme at the core of the election – actually increased annually by 1% over the past five years for those in the bottom decile, according to the OECD.

Macron has also encouraged entrepreneurship and hubs of innovation, under the flag “start-up nation”. A €10bn public fund was created to finance disruptive innovation. French tech firms raised €4.8bn during the first quarter of 2022. However, Paris has failed to attract financial businesses from the UK after Brexit. Companies prefer to list in Amsterdam, for example.

A country addicted to public spending

Macron’s slight reduction in taxation was unfunded. He was unable to curb public spending that passed 60% of GDP as the budget deficit exploded to 6.9% in 2021. Some of this relates to exceptional expenses during the pandemic, but indebtedness is spiralling out of control to €2.8trn or 113% of GDP (a total rise of €700bn during Macron’s presidency). France is addicted to public spending: the last time the country achieved a budget surplus was 1974. Back in that era, former president Valéry Giscard D’Estaing declared that if public spending reached 40% of GDP, the country could be considered socialist – it is far beyond that now. Debt and taxes are excessive and weigh significantly on the competitiveness of companies.

The trade deficit has increased to €85bn per year as France exports less and less: car production has more than halved over the past 20 years. From being a strong exporter in the nineties, France has not been able to record a trade surplus since 2005, and the trend is alarming. (The deficit is expected to exceed €100bn this year, partly due to higher commodity prices.) It has even become a net importer of food, other than spirits and wine). An agriculture sector crushed under heavy regulations and taxation cannot compete with imports. Of that €85bn deficit, €57bn results from trade within the eurozone, telling us that a lack of competitiveness with neighbours is to blame, rather than China or energy imports. The deficit with Germany exceeds €30bn, nearly twice the one with China, showing how Germany has been able to profit from naivety regarding the French-German relationship. France’s overall current account deficit that includes both goods and services reached €25.8bn last year.

More worryingly, corporate indebtedness shows no sign of decrease at 82% of GDP. This compares to 51% in Germany or 59% in the UK, and makes companies more vulnerable in a potential economic downturn led by high commodity prices. The European Central Bank (ECB) is under pressure to normalise interest rates as inflation is surging – producer price inflation (PPI) in Germany reached a staggering 30% in March – which would increase finance costs. This comes at a time when the risks of a full embargo or halt on Russian oil and gas is rising, which could push oil prices to $185 per barrel, reckons JP Morgan. That would put further pressure on corporate margins.

Another hit from Russia

Despite this, the French stockmarket has done better than you might think. Over the past five years, the CAC 40 index increased by 25%, twice the gain in the Dax 30, while the FTSE 100 remains flat. However, some long-standing French champions such as Renault are facing strong headwinds. Renault went through a number of crises over the past five years and is now at the point where its market capitalisation is smaller than the value of its stake in Nissan. To make matters far worse, its second-largest market after France is Russia. Or more accurately, it was Russia: Renault will offload its 68% stake in Avtovaz, maker of the Lada, for a symbolic €1. More painful than the immediate loss is the cost in terms of future economy of scale that has helped support the remarkable success of its Dacia division (Dacia-derived models are made and sold in Russia) and may weigh on its alliance with Nissan.

Renault is not alone. Many French companies have already made provisions for billions of euros in losses regarding their activities in Russia. It is unfortunate that finance minister Bruno Le Maire, who declared all-out economic and financial war on Russia in February, encouraged French companies to invest in Russia at the start of Macron’s term. Circumstances have changed, but it illustrates how French politicians lack vision (British politicians have, of course, performed the same shameless and unacknowledged about-turn). Now Auchan, Decathlon, LVMH, Société Générale and Total are all under pressure to close or give away their activities in Russia. One wonders who is punished the most by these sanctions.

Priorities for a second term

Macron can claim that he has once again saved democracy by beating Le Pen, but his programme is uninspiring even compared with 2017. Measures to improve women’s health, end the TV licence and tackle online harassment will not change France. There will be €15bn in annual tax cuts – not appreciated by local authorities that see their incomes cut (reduced council tax and territorial economic contribution paid by corporations). Some €35bn will be spent on key sectors such as the army, education and justice. Despite these expenses and an anticipated increase in interest rates (and thus debt-servicing costs), the public deficit is somehow expected to be less than 3% of GDP in 2027.

The most interesting points of his programme are the environment, agriculture and clean energy, especially offshore wind energy and nuclear energy. He has also vowed to adjust the European Commission’s “Farm to Fork” food strategy, which was set to reduce agricultural production by 13%.

Above all, Macron must reform the pension system. The essential task of postponing the retirement age to 65 is supported by his electoral base even though they are older and closer to retirement. However, he must be wary not to exacerbate the social divide with some of his calculated provocations. One part of France is thriving with globalisation – pensioners, inhabitants of metropoles (urban areas) and large parts of the public sector. The other part – the young and the rural – is marginalised. Thus 60% of the young supported Le Pen, while 70% of pensioners supported Macron.

Elections to the National Assembly (the lower house of parliament), which are often called the third round of the presidential elections, are due in June. However, they may be brought forward to maintain Macron’s momentum. The outcome is uncertain – he may not have a majority. The identity of the prime minister – who is appointed by the president but must have the support of the National Assembly – is anyone’s guess. Macron may have to deal with a strong left that would block pension reform. Conversely, the right-wing Les Républicains may do well despite the humiliation of their candidate Pécresse, (who won just 4.79%) and could support Macron’s proposals.

The best of the CAC 40 and beyond

Defence companies Thales (Paris: HO) and Dassault (Paris: DSY) have seen their shares rise dramatically this year and the shares are now pricey. The world is investing heavily in weaponry, but Nato countries that plan to increase spending, such as Germany and Poland, tend to buy American fighters or weapons rather than French. Mining and metals firm Eramet (Paris: ERA), long seen as struggling, has also seen its value nearly double since the beginning of the year thanks to the commodity boom.

Clean energy is probably a better place to look. Notwithstanding Renault’s (Paris: RNO) Russian disaster, note that the firm plans to spin off its electric arm (like Volvo with Polestar) in the hope of achieving a Tesla-like valuation. Furthermore, Macron promised more subsidies for the leasing of electric cars. That could benefit leasing company ALD (Paris: ALD). Renewable energy firms Volatalia (Paris: VLTSA) and Neoen (Paris: Neoen) will benefit from increased investment in the sector.

Macron has also emphasised energy preservation and house insulation. That will favour a company such as Rexel (Paris: RXL), which distributes a wide range of equipment, including renewable energy and energy efficiency products. It looks cheap on an enterprise value/earnings before interest, tax, depreciation and amortisation (EV/Ebitda) of 7.5.

Oil major Total remains cheap because of its exposure to Russia. Being forced to hand over its assets would be extremely costly. I prefer Vallourec (Paris: VK), which provides pipes for the oil business and is down significantly over the last two years. Also consider CGG (Paris: CGG), which does seismic surveying for oil explorers, as well as oil firm Maurel et Prom (Paris: MAU), which is focused on exploration.

Luxury goods firms such as LVMH (Paris: MC) and Hermès (Paris: RMS) benefit from the global rise in inequality. They are among the largest listed French companies, along with beauty giant L’Oréal (Paris: OR). The sector remains strong and LVMH reported record sales of €62bn in 2021. That said, it’s not obviously cheap: its smaller peer Kering (Paris: KER) is valued at a more attractive ratio.

Strong food brands are able to transfer inflationary pressure to customers to preserve their margins. Danone (Paris: BN) has delivered many disappointing years but looks attractive now on an EV/Ebitda ratio of ten. Fleury Michon (Paris: ALFLE), a specialist in meats and ready meals, is on an EV/Ebitda of five.

Healthcare and pharmaceuticals are a key sector: packaged medicines represent 6% of French global exports. Many medical tests and treatments have been postponed due to lockdowns and the focus on Covid-19. Guerbet (Paris: GBT), which makes contrast agents used in medical imaging, could benefit from a rebound in screening, as could diagnostics firm Eurobio Scientific (Paris: ALERS). Clinical-stage biotech firm Acticor Biotech (Paris: ALACT), which focuses on treatment of thrombotic diseases, is also an interesting one to watch.

“The calamity of Russia’s war in Ukraine has put an end to international financial investing in Russia,” Christopher Granville of TS Lombard tells Bloomberg. International investors owned an estimated $86bn in Russian equities as of the end of last year, but sanctions and a Russian ban on foreigners selling securities may leave billions of dollars trapped. Index compiler MSCI is now seeking feedback on whether to remove Russia from its stock and bond benchmarks.

The Moscow Exchange closed at the start of the week as regulators tried to head off a meltdown. The local Moex stock index is already down by more than a third this year. But while trading in Moscow was suspended, “many Russian companies are listed on overseas exchanges or trade there as depositary receipts”, says Evie Liu in Barron’s. “Those shares continued to trade on Monday, and it didn’t look pretty.”

Shares in London-listed steel business Evraz fell by 55% in five days. That is a heavy loss for “Roman Abramovich, who owns a 30% stake in the company”, says Susannah Streeter of Hargreaves Lansdown. Shares in gold miner Polymetal are down by 75% since the war began: its main buyers are Russian banks, which are being frozen out of the global financial system. Both firms look set to be relegated from the FTSE 100 at this week’s quarterly review.

Heading for default

Foreign bond investors may also get burned, says Matt Wirz in The Wall Street Journal. Russian government bonds fell more than 50% at the start of the week because of fears that sanctions could make it impossible to receive interest payments. “Russian 5.25% dollar-denominated bonds due in 2047 were quoted around 30 cents on the dollar.” This is a sign that investors think a default is very likely.

That could be financially contagious. “Banks in France and Italy each own about $25bn of Russian government bonds, and Austrian banks held roughly $17.5bn of exposure,” Ray Attrill of National Australia Bank tells the Financial Times. Thus a default would “echo through the European banking system”.

Overseas arms of Russian banks may collapse (such as Sberbank Europe), but “these are probably too small to create systemic risks”, says Neil Shearing of Capital Economics. Nonetheless, the possibility of a bank run in Russia remains a serious risk.

Still, “it is hard to conceive a complete collapse of Russia’s economy as long as it can keep selling its oil at almost $100 a barrel”, says Jon Sindreu in The Wall Street Journal. That will bring a $20bn current account surplus each month. And the plunging rouble (see below) will depress domestic consumption, which could drive that surplus even higher, towards $30bn a month, says Sofya Donets of Renaissance Capital.

Investors head for safe havens

“The idea that geopolitical uncertainty raises the gold price isn’t mere folklore,” says Chris Dillow in Investors’ Chronicle. “Since 2006, a one standard deviation rise in uncertainty has been associated on average with a $230 per oz rise in gold.” So it’s no surprise that gold has now topped $1,900 per oz for the first time in 18 months.

Other safe-havens are also drawing more interest. Bond yields – which move inversely to prices – had been rising this year on expectations of tighter monetary policy, but markets are now pricing in slower interest rate rises. Yields on the benchmark US ten-year bond have fallen back to mid-January levels. Yields on Germany’s ten-year bund have fallen back below zero. Safe-haven currencies have also risen. The Swiss franc has hit its strongest level against the euro since 2015, while the US dollar is at its strongest since June 2020.

Cryptocurrencies are also emerging as a surprising safe-haven, says Ipek Ozkardeskaya of Swissquote. Bitcoin had fallen back earlier this year, but it has gained more than 12% against the dollar since the start of February. “The coin… is now the asset that Russians and Ukrainians rely on” as their access to the traditional financial system is closed off, with strong reported purchases “using roubles and hryvnias”. But for Western investors, the idea that cryptocurrencies may be used to evade sanctions raises new regulatory risks.

“The Russian economy is at its strongest in years,” says Anna Hirtenstein in The Wall Street Journal. A “gusher of gas and oil revenues” has helped make the rouble one of the few emerging market currencies to hold its own against the dollar over the past year. Russia only needs oil prices of $40 a barrel to break even; this week Brent crude was trading at $83 a barrel. Soaring European gas prices help fill the coffers. Yet while Western oil majors rally, shares in state-controlled Gazprom are being left behind. “Geopolitics, not economics, are driving Russian markets.”

Certainly, intrepid bargain-hunters will find much to like in Russia, says Danil Kolyako on Seeking Alpha. The oil market looks likely to remain tight in 2022 and Russian stocks boast some of the most eye-catching dividend yields in the world. “The majority of Russian dividend-paying stocks are going to deliver dividend yields ranging mainly from 9% to 15% in 2021 and 2022.” That partly reflects strong commodity prices, but also the fact that with local interest rates at 8.5% – the result of “hardcore monetary policy” – dividends need to keep up.

Russian markets look “extraordinarily cheap”, agrees Paul McNamara of asset manager GAM. “Ukraine is the issue.” Despite being “the toast of emerging markets” for much of 2021, stocks have fallen 11% since October as Russian troops mass on its neighbour’s border and investors become wary, say Alexander Sazonov and Anna Andrianova on Bloomberg. If Russia were to invade Ukraine, the resulting sanctions would make it “impossible to know what you can and can’t do”, rendering the country “uninvestable”, says Elena Loven of Swedbank Robur Fonder, a Swedish asset manager that currently has investments in Russia. “If it invades Ukraine, Russia would disappear as an asset class.”

It has been “a crazy year for the Bourse de Paris”, says Quentin Soubranne on BFM Bourse. France’s CAC 40 gained 29% in 2021, making it the world’s best performing major stockmarket. The gain is the index’s best annual performance since 1999, as a strong economic rebound and easy money from the European Central Bank (ECB) pushed it to record highs.

The pandemic has changed the composition of CAC 40, says Bastien Bouchaud in Les Echos. Once the preserve of banks and oil companies, today the index is increasingly dominated by luxury and industrial firms. Between them the four big French fashion groups (LVMH, Hermès, L’Oréal and Kering) have generated “more than half of the index’s gains over the past two years”. Unable to travel, the world’s wealthy have been splurging on luxury goods instead. Green energy industrial firms and France’s handful of tech companies are also growing fast.

European stocks have had mixed fortunes

Elsewhere in Europe, it was a good year for Amsterdam’s AEX (up 27.5%) and Italy’s FTSE MIB (up 23%), says Danilo Masoni on Reuters. Germany’s Dax (up 15.6%) was less impressive, while Spain’s Ibex lagged behind, managing to climb just 7.4%. The pan-European Stoxx 600 index finished up by more than 22%, its second-best showing since 2009 – although this still lagged the near-27% gain of America’s S&P 500 index.

The big question for 2022 is whether European stocks can finally beat the S&P 500, which has delivered superior returns for most of the past decade, says Nikos Chrysoloras on Bloomberg. Strategists at Deutsche Bank and Jefferies think they might. While the US Federal Reserve is poised to start hiking interest rates soon, the ECB has indicated that it is in no hurry to do likewise. That should provide more of a cushion for European stocks, as easy money usually finds its way into markets. Valuations in Europe are also less stretched than in America. US price-to-earnings multiples are now 10% above pre-pandemic levels, but those in Europe remain 20% lower.

Inflation risks

The outlook for the first part of the year is encouraging, says Martin Skanberg of Schroders. Eurozone corporate profits rose roughly 50% year-on-year in 2021, with companies able to protect margins by passing price rises onto consumers. The continent boasts plenty of “market leaders” in the popular green themes of “renewable fuels, electric cars or metals recycling”. The big risk is that with inflation running at 4.9% in November, the ECB may yet be forced to tighten monetary policy more quickly than expected. As elsewhere, that could spell the end of the stockmarket party.

Investors have long despaired of Italy, says Miles Johnson in the Financial Times. The economy has barely grown since 2000. “Anyone who purchased Italian equities at the start of 1999… has lost a fifth of their investment.” But now things are looking up under prime minister Mario Draghi’s unity government.

Italy’s government debt-to-GDP ratio of 155% is the second-highest in Europe, behind only Greece. For now, massive bond buying by the European Central Bank (ECB) is keeping borrowing costs low: at 0.85% Italy’s ten-year government bond yield is barely higher than the UK’s. But a brief spike in the gap with German bond yields earlier this month was a reminder that Italian debt is underpinned by the ECB’s stimulus. To solve its debt problems Italy needs growth.

Reform in Rome

Draghi’s government is shaking up Italy’s sluggish bureaucracy and courts, says Anna Momigliano in Foreign Policy. “By far the slowest in the European Union… civil proceedings can often last up to seven years,” which scares away international investors. The government is giving extra resources to the overwhelmed judiciary to help clear a backlog of cases and is imposing a new timetable to accelerate legal processes. Rome will receive the biggest slice of the EU’s pandemic recovery fund over the next five years: €191.5bn. Spending priorities include insulating buildings and rolling out new digital and rail infrastructure. That money should provide a steady tailwind for the economy. Italy’s FTSE MIB index has returned 23% so far this year, more than double the FTSE 100’s performance over the same period.

A country that has had seven prime ministers in the past decade is enjoying a rare moment of political calm, says Tom Rees in The Daily Telegraph. But another storm may not be far away. The Italian president’s term ends next February and Draghi is tipped to replace him. That could lead to early elections the far right is well placed to win. Investors have long feared that outcome, but Italy’s right is not the threat to the euro that it once was after toning down its criticisms of Brussels in recent years.

A key concern is that a new government could unpick Draghi’s reforms, says Nick Andrews of Gavekal Research. Yet Brussels has a “trump card… it can pull the plug on recovery fund transfers”. That should encourage Italian politicians to keep reforms on track. Italy’s debt woes date back to the 1980s, a period marked by excessive spending and overmighty trade unions.

Rome has done a better job at balancing the books since it joined the euro, but a lack of growth has kept debt levels high. Turning around the economy is a formidable task, but for “the first time in decades Italy does look to be headed the right way”.

Subscribe to the MoneyWeek Podcast on one of these platforms:

• Apple Podcasts
• Spotify
• Google Podcasts
• Spreaker
• Podbean
• Audible

Transcript

Merryn Somerset Webb: Hello and welcome to the MoneyWeek magazine podcast. I am Merryn Somerset Webb, editor-in-chief of the magazine. Thank you for joining us today. Today, I have with me Dale Robertson, who is the co-manager of the… I find this a very hard word to say, Dale. I don’t know if this is just me, but Chelverton.

Dale Robertson: Chelverton, with an L.

Merryn: I think it is something about the H and the L that makes it kind of hard but, anyway, co-manager of the Chelverton European Select Fund. That is not a criticism of the name, by the way. It’s a great name. I just find it quite difficult to say.

Now, this is a relatively new fund launched in 2018, so has been going for about three years but it has got rather a good record, an annualised return of over 17% over those three years, so at 62%, up 53% in the last year, and the fund has also been growing very fast.

And, we’re always interested at MoneyWeek at encouraging people to look at funds in the early part of their growth because performance tends to be much better and that looks like it is the case here. So, thank you very much for joining us.

Dale: Thank you, Merryn, for having me. Delighted to be here.

Merryn: Excellent. It would be awful if you weren’t. Let’s start by talking about why you launched a Europe fund in 2018. Why Europe then and why Europe now?

Dale: Well, Europe is a great place to be a stock picker. There is just such huge variety within Europe. There are so many different countries, so many different cultures, so many different specialisms, sectors, subsectors. There are large parts of Europe which are overlooked and I hope we’re going to go on and talk about that because there are a lot of mispricings at the small end of the European market cap spectrum.

You can get value and you can get growth into the same portfolio we believe. So, I think you can construct a really interesting portfolio in Europe which gives you really interesting long-term structural growth dynamics which are not beholden to the macro concerns that people tend to have about Europe, politics, sclerotic growth, another French government intervention into the corporate sector.

If you scratch below the surface there are a lot of really exciting things happening in Europe but you have to be prepared to roll up your sleeves and get down into, in particular, small and micro-caps. Just for clarity, the fund itself is Europe ex-UK. It is all-cap. We like the flexibility to go anywhere in the market cap spectrum but we expect to add most of our value and returns in the small and mid-cap part of the market.

Right now, for example, very roughly speaking, we’ve got 30% in large-cap, 20% in mid and 50% of the fund in small-cap. We think the fund can be a one-stop-shop for people’s European exposure, accepting that there will be this small and mid-cap bias over the long-term.

Merryn: Let’s just step back a bit.

Dale: Sure.

Merryn: So, the impetus for starting the fund is nothing to do with the macro environment?

Dale: No. I think that’s right. I’ve been investing in Europe for quite a number of years and selling Europe on a macro, top-down is actually quite tough. There’s a bunch of reasons for that. The demographics aren’t quite as good as Asia or the US.

It tends to deliver lower GDP growth. You have political cycles. You’ve got one monetary policy and then a whole bunch of different fiscal policies. You’ve got a mismatch of economic management.

So, there’s a lot of things you could be worried about in Europe but that really does disguise the fact that there is a lot of really interesting things happening. But, as I say, you do have to prepare to roll up your sleeves and get into the smaller end of the market cap spectrum.

It’s about variety and growth and because Europe tends to be overlooked from an asset allocation point of view you tend to have lower starting valuations and oftentimes that is merited.

We’re going to come on and talk about examples, of course, but there’s a lot of good examples of companies that have the same growth dynamics and the same financial productivity metrics as many larger cap or US-listed companies but they are just much, much cheaper.

Merryn: It is interesting. The first thing we always do these days is compare to America. We look at everything through the lens of valuations in America.

Dale: That’s right, yes.

Merryn: You could also look at it the other way round and say, well, American valuations are completely insane by any historical standard, so we really should put that to one side and stop comparing to America and say on an absolute level are the valuations in any particular area we’re looking at low? And, I think you could argue fairly easily that in fact European valuations aren’t low either relative to historical levels. In fact, in many areas they’re hitting new records.

Dale: If you look at the aggregate, Merryn, I think that’s right but you have to be aware of the structure of the European market before you think about the aggregate valuation. This is not really scientific but we tend to think of Europe in three different parts of the market and the first part is what we’d term high quality growth.

Europe is very good at a number of different things. It is very good at consumer goods. The biggest companies in Europe are L'Oréal, which is haircare and personal care products, it is LVMH, which is luxury goods, it is ASML, which is one of the largest semiconductor capital equipment companies. So, there are a lot of very, very good companies in Europe.

They are super companies. We have no issue with the companies, their growth prospects, what they’ve delivered, it is just the valuation that people have paid for them is way too high. When you look at the structure of the European market, it is these high quality growth companies that have driven the aggregate valuations high.

That is the first segment and that’s not where we’re playing. Occasionally, we will have an opportunity in there but not very often. The second segment of the market, this is maybe not the right term but it’s corporate dinosaurs. You’ve got a whole bunch of companies which are in telecoms, utilities, energy, financial sector, which are either government-owned, government owns stakes in them or they’re government influenced, government regulated.

They tend to be capital intensive and they tend to have leveraged balance sheets and they have problems becoming efficient because of the influence of the government in them and Europe does have a quite high preponderance of companies like that. Again, we can find the odd idea in here but, again, that’s not where we play

I’ve listened to some of your podcasts in recent weeks. They’ve been very good and I know part of your questioning to some of the participants have been about value and deep value, and if you’re constructing a deep value portfolio in Europe, this is where you’d be.

You’d end up with a portfolio which looks like those characteristics I just mentioned. To me, you can make money there but actually the best place to look is in the very, very long tail of companies in Europe which is at the small end of the market. We reckon we’ve got probably over 3,000 companies we can invest in and over 2,000 of them are small-caps.

There are a couple of points I’d like to make here. Chelverton, as an organisation, has made its name, if you like, for belief in the small-cap effect. We have constructed a strong small-cap bias through all the funds that we manage.

Merryn: You better talk us through the small-cap effect as you see it. Lots of our readers are investors but we do have some readers who aren’t necessarily experienced investors.

Dale: Sure. The small-cap effect is relatively simply which is that a could small one should outperform a good large one. It just really means because they are smaller, they have much more room to grow. We have a number of companies. We’ve got the 60-odd stocks in our portfolio, 30-35 in small-cap and a lot of the companies we hold down here, we’d expect them to double their sales over three, five, seven years and the same cannot be said of the much larger companies.

This is just the idea that smaller companies can grow quicker but, also, the other part of this is that there are more inefficiencies in this part of the market. It is not just me saying a small company will outperform a large company as a glib one-liner. There is quite a lot of empirical support to this over a very long period of time, not just in Europe of course, across all sectors.

But, this has been exaggerated by regulation and by MiFID II. What happened when MiFID II came along is that research budgets across the sales side who were producing all the research were slashed and so a lot of the coverage of those companies fell away.

What that means is there a lot of companies, we tend to think in euros, sub-€1.0 billion, sub-€500 million market cap companies where there is little or no research coverage. This is creating inefficiencies, mispricings and that is the really exciting opportunity for us.

Merryn: So, how do you manage the research then? You have quite a small team, so how are you covering all these thousands and thousands of companies across Europe?

Dale: This would have been a lot more difficult to do 25 years ago but technology has allowed us to create these tools, which means we can interrogate a universe very quickly, looking for the criteria, the types of things that we look for.

We are pretty fundamental. We look at cash flows. We spend a lot of time looking at quality, integrity, long-term sustainability of companies, cash flows but when you’re when you’re starting off with a universe of 3,000 companies, you start off with some high level of screening tools and you can do with very easily if you look at their proportion of free cashflow or companies translating from cash.

So, you start off with a big universe. You can narrow it down but we did this on day one. All the heavy lifting was done before we launched the fund. Our basic belief is and I’ve worked in different environments over the years as an individual.

Gareth Rudd is the Co-Manager of the fund. We both regard ourselves as analysts, first and foremost, and portfolio managers second because we spend so much of our time analysing companies and we get pretty in-depth on the cash flows of the companies we invest in.

I think Gareth is quite fond of using the term private equity-light, in terms of our approach. Our fundamental focus is on a company’s ability to generate what we call free cash flow and free cash flow is quite simple. It’s a bit like disposable income on a personal level.

So, it is what you have left over to do the good stuff with at the end of the month and, at a corporate level, if a company has got good free cash flow, it allows them to pay dividends and it allows them to reinvest in long-term growth opportunities. So, we’re very focused on free cash flows and we think it is poorly done by the market.

Merryn: Sorry to interrupt. I’m not supposed to interrupt but I am interrupting. But, you’re not focused on dividends. You say the free cash flow gives companies the ability to pay dividends but the yield on the fund is very low, so it is clearly not one of your priorities.

Dale: We’re agnostic as to how our companies spend their free cash flow. This is not a fund that should be considered for income but having said that I think the net dividend yield, it is still settling down post-COVID obviously but it is going to be somewhere between 1.5-2.0%. This is not really a fund to think about for income.

What we spend our time doing is looking at how our companies allocate that free cash flow. If a company has got a lot of growth potential, we’d obviously be expecting them to reinvest in that growth potential and therefore pay out lower dividends and vice versa.

We will invest in companies where a large part of the investment case is 5-6% dividend yield because we think that sensible. To have a few stocks like that in the portfolio is sensible for diversification reasons.

So, that’s the approach. Stylistically, I think I mentioned this at the very start. We look for value and growth. We think that the market has done the great job in pigeonholing managers. You’re a growth manager or you’re a growth fund or a value manager with a value fund.

We are sort of with Warren Buffett on this. Warren Buffett poo-poos the way the world has been cut up in this way and his quote ,which I won’t get exactly right but it is something like if you are calculating the value of a company, you need to incorporate the growth of that company.

We completely agree with that. What we’re trying to find is a blend of value and growth. Specifically, we look for cheap cash flows from a company and we also look for faster growth than the market. A good company for us will be on a free cash flow yield above the market.

You mentioned absolute valuations earlier. In Europe, the market overall is in a free cash flow yield of 3.5%, give or take. Our portfolio is in a free cash flow yield of about 6%. So, we have got significantly cheaper cash flows than the market.

We look at companies that are growing faster than the market. The growth at the moment, the three-year sales growth of the European Index overall is about 6-7%, boosted by this year and the COVID bounceback and our fund has got three-year sales growth of about 9%. So, we do think you can find a blend of value and growth, cheaper cash flows and better long-term growth prospects by digging down.

Merryn: All right. Well, let’s talk about some of the companies in the portfolio then. I know that you’re small-cap based but when I look at the top ten, which I’ve got here, a couple of them look pretty big. Unilever, right at the top.

Dale: Yes, yes, yes. We’re unapologetic about that.

Merryn: Go on then. Be unapologetic about it. Tell us about it.

Dale: Absolutely. Our objective is to have a balanced, diversified exposure to Europe. I mentioned we’ve got this unconstrained approach and there can and will be times. We expect to add most of our value in small and mid-caps but there will be times when large-caps fall out of favour and they look cheap and that is where we are with a few of the large-caps.

You’ll see in our top ten we’ve got Unilever, we’ve got Novartis and one or two others. Unilever shares are trading at the same price they were five years ago. We believe the company has made progress over the five years. It might have started on too high a valuation but right now it is on a 5-6% free cash flow yield.

It is not our favourite metric but in P/E terms that is probably about 18%. You’ve got very good emerging market exposure, good pricing power, which is pretty important at the moment because of inflation and it has just been left behind because the market has got excited about all the stuff which is bouncing back from the COVID lows.

We will invest to give the fund balanced diversification in large-caps when they fall out of favour. But, if we are to talk about stock ideas and some of the exciting clusters, if you like, that are in the fund, I do want to mention technology and technology exposure because one of the things that people beat Europe up about is lack of technology exposure.

If you want technology exposure, you go to the US and you buy Amazon, Facebook, et al, or you used to be able to go to China and buy Baidu, Tencent until the Chinese government started clamping down on those organisations.

Then, Europe is squeezed out in the middle. It has got one or two very good large-cap technology companies like ASML, I mentioned, SAP, which is enterprise software. We don’t particularly like the valuations of those companies but we do think you can find a lot of really interesting technology exposure at the small cap end of Europe which is overlooked.

We had a brilliant example, actually, just last week with a small German company. Gareth met them at a conference a couple of weeks ago. He arranged a follow-up call, so we spent an hour and a half on the phone with one of the two co-founders of this company.

Merryn: Interruption... Did they come up in your screenings, this company? You say you met them at a conference. Does that mean it was the first sign of them?

Dale: No, they didn’t.

Merryn: So, they didn’t come up in your models.

Dale: They didn’t come up in the screens. Screens only really get you so far. That’s the reality of it.

Merryn: So, you screen but then you’ve got to get out and about to conferences and talk to people and get on the phone and travel to really find this stuff?

Dale: Absolutely, yes.

Merryn: Sorry. Back to meeting them at a conference.

Dale: I would say that is especially true at the small-cap end of the spectrum. It is less true the large-cap end of the spectrum. This company is called Serviceware. It’s a German software company. It produces software which analyses the efficiency of companies’ IT spending.

It is quite a niche but it is growing at 15-20%, top line growth of 15-20%. Its market cap is about 150-160 million. I’m thinking in euros here. And, it has got one peer. It has one peer in America which is confusingly called ServiceNow, which is 120 billion market cap. It has got 5.0 billion of sales, so it is on 20x sales and this company is on 1.5 times sales.

This company don’t have the same margin structure yet because they’re less mature but there’s no reason that this company over the next three to five years can’t deliver a mature software company margin, which is 20-30%.

If they do that, we could certainly argue your point earlier, it was entirely valid, that 20x sales is probably completely wrong but 1.5 times sales is also completely wrong in the other direction.

We find a lot of examples like this and we spoke to co-founder. The two co-founders own just over 50% of this company and they said, look, we IPOed three years ago and two of the three banks which were covering us dropped coverage, took their investment banking fees and just kind of ran away.

The sell-side company, which is doing research on Serviceware, they produce something twice a year. It’s a one-pager which covers the company’s earnings and the company’s earnings is not where the value is here. It is in the potential long-term cash flows. So, it is just an example of the under-research and the opportunity at this end of the market cap spectrum.

That is one example that came up recently but we have got 25% of our fund in the IT services sector, so technology services. These are companies, they’re staffed by IT consultants. They are writing software.

They are going into their clients, helping them with digitalisation, helping with managing all their big data, inverted commas, problems and opportunities, helping them figure out how to use AI to their best benefit, helping them with the Internet of Things. They’re technology consultants and they are software and hardware agnostic, so they will sell whatever the best solution is for the client.

IT budgets are growing up and up and up and it is reinforced by COVID, of course. So, we think people want to get technology exposure but it is very difficult to get good value technology exposure. As I say, it is 25% of the fund. We’ve got 16 or 17 companies in there, right across Europe, all with different sector specialisms and different software, hardware blend of what they provide.

Merryn: Can we have an example of a favourite stock in the sector?

Dale: Of course. We’ve got a whole bunch.

Merryn: Just one. Maybe two.

Dale: Yes. I’m going to give you two or three.

Merryn: Go on. Give us two or three.

Dale: I stood up at a conference, I don’t know when it was. It dates this a little bit. I was asked for one stock pick and I gave them Nokia as a stock pick and this was at a time when Nokia had just missed the switch to clamshell phones, remember that, 20 years ago, and Nokia was a complete disastrous investment after that. Ever since I’ve been asked for individual stock picks, I usually caveat it with two or three in case one goes wrong.

Merryn: Good call.

Dale: In this sector I would highlight Bouvet. Bouvet is a small Norwegian IT service company. They work very closely with the Norwegian government and they work with the energy sector and it grows its revenues pretty much year in, year out, 10-12%. There is a bit of margin expansion, so you have got good cash flow growth.

It does not do acquisitions, so it pays pretty healthy dividends. This one has got growth and about a 3.5-4.0% dividend yield. This is, obviously, Norwegian krone. So, it is a super wee company. Its staff turnover is very low, which is something we look for in all these consultancy companies because people management is so important. Wages are going up and we want our companies to have a stable, motivated workforce.

So, Bouvet I would certainly highlight. There are a couple of French companies run by really interesting entrepreneurs. Sword and Infotel would be two I would highlight. Sword, it is not a mini-tech conglomerate. Yes, it probably is. It has got five or six different areas. One, probably their most profitable area, they produce compliance software which is a rapidly growing area. It’s probably growing at 15-20%.

Merryn: I think we might need a brief explanation of what you mean by compliance software.

Dale: It’s software which helps the compliance departments of banks monitor all the regulatory risk which they have within their organisation. It’s been an increasing area and the banks need external software, external help to help them comply with the various regulations. Yes, sorry about that jargon.

This is a really interestingly run company. It is about 300 million market cap. Its CEO is a chap called Jacques Mottard and he has been very, very good at managing his assets. He has sold and bought assets very well.

At the start of this year he had probably 20-30% of his market cap in cash and he decided there was nothing he wanted to buy, so he paid a 14% dividend yield. It is quite a quirky situation but very good long-term growth dynamics.

I want to digress slightly to make a more structural point before I come back to the other example, Infotel, but one of the things which we do in our process is that we like to co-invest alongside motivated owners, be that CEOs, be that family, be that supervisory board membership, chairmen.

It is just a long time experience of investing in Europe that you want to be co-investing alongside people who have got skin in the game. So, we always invest in small companies where we’re co-investing with someone.

Free cash is really important to us, so the capital allocation of that free cash flow is really important and we think if you are co-investing alongside motivated long-term owners, it should help you in the long-term. You’ll find us talking like that all the time when we talks about companies.

The next one, Infotel. Again, it’s French and it was set up by two guys who are now in their 60s, 30-40 years ago. Again, it is technology services to their clients. Their clients would be large-cap French corporate world.

They work with Peugeot, with Renault, with BNP Paribas, with Air France and many years ago they would have helped them set up their websites and then they would help them develop their apps. Now, their work encroaches into lots of different parts of their organisations so, again, these guys grow at 7-8-9% top line per annum.

They generate a lot of cash. It is an asset-light business, so it has got a very good cash return on investment. I think there market cap is about the same, funnily enough, about 300 million, but they have a lot of cash on the balance sheet as well.

You would look at that one on a P/E and my guess is the headline P/E would 20x but because it has got about a third of its market cap in cash, really you’ve got to strip that out, so it’s probably on 13-14x or in language we prefer, it’s a 7% free cash flow yield which is really very attractive.

At some point these guys will pass over the reins and you might find you get corporate event at some point in time, way down the line. So, these are good companies to be co-invested with the managers. We think long-term.

Merryn: Now, if you’ve got some of these smaller companies in your top ten holdings, what is the maximum percentage of a company you’re prepared to hold. Apart from anything else, your assets under management are growing very fast.

Dale: Yes. We’ve got an informal glass ceiling of about 4-5% ownership of company. Some of the biggest opportunities we see are in micro-caps, a sub-500 million market cap and some of them are sub-200 and they are pretty small companies.

We have to do extra due diligence on the cash flows. Well, not extra, we do this as a matter of course. The cash flows, the balance sheet strength is very important to us and the co-investment alongside management is really important.

A lot of the companies that we are invested in, we expect to be invested with them for five or ten years basically. What got us on to this IT services sector many years ago is when we launched the fund we had a position in Capgemini, which is one of the large-cap IT consultants.

We liked the dynamics of that and we started looking around for other ideas. I ended up going to Helsinki for a day and spend five hours with this company could Siili Solutions. It is this really small company. One hundred-and-something million market cap.

It was really, really interesting because it basically gave us our investment case for the sector because when I spoke to IT consultations about the work they were doing, they said, look, if you’re an IT consultant in Capgemini or Accenture you’re a very small cog in a big wheel. You get lost in these enormous great IT projects, outsourcing projects.

Whereas, at Siili, this little company, they were working with the German car OEMs and they’re designing what they call the cockpit which to you and I is the dashboard of the car. So, they’re designing the hardware for the next generation of electric vehicles for these cars.

That is really leading edge, really interesting work but you would not get that in one of the larger consultancies. So, we built our IT exposure up by, as you mentioned earlier, going out to see these companies asking them, look, when you lose staff who do you lose them to?

They say, oh, there’s a company down the road. So, we go and speak to them and that’s how we’ve built up our exposure there, just by digging around basically and being inquisitive.

Merryn: This all sounds really interesting, sounds exciting. We can feel your enthusiasm for it all.

Dale: But?

Merryn: But, what makes you nervous right now? What keeps you up at night? I know you say you don’t worry about macro stuff but inflation, rising interest rates, central bank policy mistake. What is it? What keeps you up at night?

Dale: Well, all of that could keep us at night.

Merryn: But, it doesn’t?

Dale: Let’s step back for a minute. We have 70% of the fund in small and mid-caps and of course small and mid-caps are going to go through cycles. The observation that I hope is coming over is that the opportunity we see at the small cap is structural.

There is mispricing at this end of the market and, even if the small caps do go through a cycle, I can see the point in the management of the fund where rather than have 30% in large, we have a lot less and a lot more small-cap if we’re offered that opportunity.

Small-caps will go through cycles and what do we really mean by that? Well, we mean good small-caps get caught up in a downdraft of a selloff. Of course, that can happen and what brings that about? Inflation and interest rates are two of the most obvious candidates.

But, when we think about inflation, there’s a couple of levels to be thinking about it. The strength and the breadth of the anecdotes that we get from our companies about inflation suggest that it is pretty real.

I’ve alluded to it, we’re not macroeconomic specialists here but it does feel that there’s a lot of inflation in the pipe and that’s right across our portfolio. Our approach is twofold. What we spend time doing is making sure that our companies are able to pass on price inflation, so at least that is protecting their margins. So, that’s a bottom-up level of analysis.

The company, Bouvet, I mentioned earlier, a Norwegian company, they said wage inflation – because there is a shortage of IT consultants around in many countries in Europe – wage inflation is now running at 4%.

They said, look, we will be able to pass it on to our clients but we can’t do that until 1st January when we review their contracts and, by the way, they will pass on more than the 4%. So, they do have pricing power, they are able to pass it on but there might be a little bit of a time lag.

But, I think your question really was a bigger picture one about inflation. If inflation takes hold then that obviously changes the structural narrative that we’ve seen for the last decade, if not longer and in practical terms what that means is inflation goes up, the yield curve goes up, interest rates go up and the discount rate, which people use to value the cash flows of high growth companies, should punish those companies.

So, the high growth companies I mentioned right across the world but in my area of expertise in Europe look very vulnerable but, for us, I mentioned that the fund has a 6% free cash flow yield. We are not going to be completely insulated from that, of course, but we do feel valuation discipline.

We’re two pretty tight-fisted Scotsmen, basically. Valuation discipline is in our DNA and whilst we may get a hit from something which has gone on elsewhere, we do feel that the valuation should protect us in a relative sense.

There are lots of things you could be cautious about and cite as reasons for caution but what gets us excited, gets us out of bed is stock picking and we still keep finding lots of good ideas. The valuation of the fund, you mentioned very kindly that the fund has done reasonably well recently but if you look at the valuation of our fund 12 months ago it was on a 6% free cash flow yield.

Today, it’s on a 6% free cash flow yield despite having gone up a lot in the interim which means that we’re able to recycle from more expensive companies into cheaper companies and that, to me, is the most encouraging thing and probably the most encouraging message I can give.

Merryn: Brilliant. I think we’re all pleased to take that message. Dale, we’ll have to leave it there. Thank you so much for joining us today. We hugely appreciate it and I hope you’ll come on again at some point.

Dale: Yes. We’re delighted. Thanks. Thanks for having me.

Merryn: And, thank you, everyone, very much for listening. You can, of course, find more from us at moneyweek.com, where you can sign up for our daily newsletter, Money Morning, and of course you can follow us on Twitter @MoneyWeek. You can follow me on Twitter @MerrynSW. Dale, can we follow you on Twitter?

Dale: No. I’m afraid you can’t.

Merryn: No, we can’t. We get that answer a lot these days. There’s an awful lot of people who cannot be followed on Twitter and otherwise, of course, please do leave a review for the podcast on your podcast provider of choice if you enjoyed the podcast. Thank you very much and we will talk to you again next week. Thanks, Dale.

“Over the last 15 years Germany has come to be seen by many in Europe as a paragon of political stability”, says Ronald G. Asch in The Spectator. Now Angela Merkel, the country’s “perennial chancellor”, is preparing to retire. An election on 26 September will decide who replaces her at the helm of Europe’s biggest economy.

The next coalition

The election campaign has proved volatile. The centre-left Social Democrats (SPD) have soared in the polls in recent weeks at the expense of Merkel’s conservative CDU. Gaffes by the “buffoonish” Armin Laschet, the CDU’s candidate to succeed Merkel, have alienated voters. They have taken a shine to SPD candidate Olaf Scholz, who currently serves as the finance minister in a coalition government with Merkel’s party. Scholz seems “serious-minded” and “pleasantly boring – something very much appreciated by the majority of German voters”.

Scholz’s SPD is proposing “a suite of progressive but modest economic policies”, says Tom Rees in The Daily Telegraph. The party wants to boost public investment, using tax increases to pay for it. If the SPD manages to “maintain its present momentum” then it will probably favour a coalition with the liberal Free Democrats and the Greens, says Cedric Gemehl of Gavekal Research. The parties’ respective red/yellow/green colours mean that combination is dubbed a “traffic light coalition”.

Such a coalition would not be “revolutionary”: Germany’s constitutional “debt brake”, which limits government deficits, would probably be left untouched. But an SPD-led government would still be more “fiscally proactive” and more favourable to European integration than the present one.

The blue-chip index expands

It is not just Germany’s political system that is heading for a shake-up. The benchmark Dax stock index will soon be grappling with a new government and will also expand to 40 companies from the current 30 on 20 September. The changes are part of a broader shakeup in response to last year’s Wirecard fiasco, says Brigitte Scholtes in Deutsche Welle. The former Dax constituent went bust last year following a major accounting scandal.

Operator Deutsche Börse has tightened rules about corporate governance and will require firms to be profitable before they can be included in the index in the future. The new members will include Porsche and sportswear brand Puma. Aircraft manufacturer Airbus and online clothes seller Zalando have also made the cut.

The Dax was founded in 1988, says Joe Miller in the Financial Times. Since then it has delivered a total return comparable to that of the FTSE 100 over the same period, averaging 8.6% annually. The expansion reflects a concern that the index had become overly weighted towards old economy industries such as carmakers, banks and industrial groups. By offering a broader selection of companies, a bigger Dax should give investors a more accurate cross-section of the German economy.

“Global investors have had little love for Europe in the past decade,” says Nicholas Jasinski in Barron’s. “Anaemic” growth and political instability “have kept a lid on European stocks”. Yet with reopening gathering pace, “the near-term case for relative outperformance by Europe now is the strongest in years”. The pan-European Stoxx 600 index ended the first half of the year last week with a 13.5% gain.

Pack your vaccine passport

Last week the EU launched its vaccine passport, providing a shot in the arm for the tourism industry ahead of the summer season. Brussels and London are working on mutual recognition of the NHS Covid Pass. More than half of the EU’s population has now received at least one dose of a Covid-19 vaccine, with countries such as Germany, the Netherlands and Spain currently outstripping the US on this measure.

European data has surprised on the upside recently, says a Morgan Stanley note. The European Commission’s economic sentiment indicator is at a 21-year high. The US has now passed through the fastest phase of its recovery and there is nervousness about the outlook for monetary policy, says Jasinski. By contrast, Europe’s recovery is only just starting. Indeed, it is “one of the few developed regions” tipped to “see better GDP gains in 2022 than in 2021”. On 16.5 times 2022 earnings the Stoxx 600 is also a welcome remedy for US “valuation vertigo”.

Most investment banks are tipping European markets to outperform the US for “the remainder of the year and into 2022”, says Elliot Smith for CNBC. US fund flows into European stocks so far this year have been the strongest in six years. BNP Paribas’s strategists think easy monetary policy and a broad-based recovery will benefit Europe’s numerous value stocks: the banks, carmakers and energy companies that have been left behind as US tech has soared over the past decade. European shares look well-placed to benefit from the next stage of the recovery, agrees David Brenchley in The Times. Sectors “such as payments, medical technology and green energy” also look promising.

The bull case for Europe extends beyond reopening, says Graham Secker in the Financial Times. Europe’s post-pandemic recovery fund, which has seen member states issue joint bonds for the first time, is a “game-changer”. The fund’s slow rollout has drawn unfavourable comparisons with the much bigger US fiscal stimulus. But while America has created a short-term consumption surge, the European plan is “more focused on longer-term investment” in areas such as digitalisation and provides extra help to weaker peripheral economies. The five-year time horizon should also mean it provides a more consistent tailwind for European equities in the coming years.

US president Joe Biden’s mammoth $1.9trn relief bill has left Europe’s own stimulus efforts looking scrawny, says Johanna Treeck in Politico. Figures from the Organisation for Economic Co-operation and Development show that US pandemic stimulus measures amount to 13% of GDP, much higher than the 7% spent in the eurozone.

That partly reflects America’s lack of a social safety-net, which forced Washington to step in with extra spending last year, Nicolas Goetzmann of asset manager Financière de la Cité told Aziliz Le Corre in Le Figaro. Nevertheless, there is now a “chasm” between US fiscal largesse and Europe’s more cautious approach.

The recovery gap

The result? The European Central Bank projects that the euro area won’t regain its pre-crisis GDP until the second quarter of 2022, a year behind the US. Europe’s policymakers are reluctant to part with their “old economic totems” of budgetary discipline above everything else.

The stockmarket doesn’t seem to mind, says Anna Hirtenstein in The Wall Street Journal. The Euro Stoxx 50 index is up by 7.5% for the year to date, compared with the S&P 500’s 6.5% gain. Italy’s FTSE MIB has returned more than 8%. The continent’s bourses are profiting from the ongoing “rotation” from growth to value stocks.

European markets are heavily weighted towards value sectors such as financials, industrial and energy companies, which jointly comprise 38% of the pan-European Euro Stoxx 600 index. The recent uptick in yields has also boosted the region’s unloved banks.

Super Mario

Despite a “sometimes sclerotic image”, Europe remains “a world leader” in sectors such as luxury goods (Louis Vuitton, Gucci), cars (Daimler) and “high-end engineering” (Siemens), notes Martin Sandbu in the Financial Times. An early push into green policies has helped renewable-energy businesses steal a march on the global competition.

Europe’s growing technology scene is often overlooked, adds Stefan Wagstyl in the same paper. While lacking household names to rival Facebook or Apple, the continent specialises in the “nuts and bolts” of industrial and business-to-business tech; Dutch firm ASML plays a vital role in global chip production. Europe isn’t perfect, but “it’s a lot better than many investors think”. The news is also brightening on the political front, says The Economist. Recent Dutch election results could make one of the EU’s most frugal members “a tad less parsimonious”. New Italian prime minister Mario Draghi is rallying support for much-needed reforms to Italy’s complicated tax code.

Mebane Faber of Cambria Investment Management notes that Italian shares started 2021 on a cyclically adjusted price/earnings (Cape) ratio of 19.8, a discount to Japan. On 18.7, German stocks are 50% cheaper than their US peers. Spain, on 13.6, is even cheaper than the FTSE 100. The lack of any US-style speculative exuberance in Europe, says The Economist, is a plus for investors seeking less GameStop-style drama and more “deep value”.

Investors in Europe are hoping that 2021 proves a duller year than 2020. Last year was one to forget, with the pan-European Stoxx 600 finishing down by 3.8%. The pain was not evenly shared. Spain’s IBEX finished the year down almost 15%, with France’s CAC falling by 7.1%. More happily, Germany’s Dax delivered a positive total return of 3.5%.

The MSCI Europe index, which includes British shares, posted its worst annual performance since the 1980s relative to the world average last year, says Morgan Stanley in a research note. European earnings may have fallen by 33%, more than double the global average of 15%. But a strong cyclical recovery is likely to take hold later this year, triggering a multi-year surge in profits. That should feed into stock prices, which closely track earnings trends – in 2004-2005, the last time the region enjoyed two successive years of 20%+ profit growth, the MSCI Europe index returned 33%.

European stockmarkets are a decent bet

The underperformance of European markets has little to do with geography and almost everything to do with sectoral make-up, says Richard Cookson on Bloomberg. Around 28% of large-cap US stocks are technology firms. In Europe that figure is 7%; in the UK it is just 1.5%. Almost 4% of the European market is made up of beaten-down energy stocks, compared to 2% in America. Indeed, if you correct for sectoral weighting, European and American stocks would have “pretty much the same valuation”.

Surging tech stock prices and the rout in the energy sector have “whittled away” at that problem, says Buttonwood in The Economist. Tech firms now account for 14% of the Euro Stoxx 50, an index of eurozone blue-chips, making it the continent’s biggest sector.

That said, the case for European shares still rests squarely on the outlook for those hated “old-economy cyclical stocks” (banks, energy and industrials). A post-pandemic reflation trade should help them outperform over the next two years.

My worry is that we will get an inflation spike in major economies later this year, says Cookson. That could scare central bankers into hiking interest rates. If that happens then pricy US stocks would feel most of the pain, but European cyclicals would not be spared.

If interest rates and the dollar do rise, then European equities look better than the alternatives, says Buttonwood. Tighter global monetary policy would be especially painful for emerging markets, leaving Europe the “sounder bet”.

Fortune will “favour the brave” for European equity investors in 2021, says Rodney Hobson for Interactive Investor. The key is to look for “solid, boring companies that can stand the shutdowns” and are ready to profit once the recovery begins.

The 2010s was a dismal decade for Europe. It began with the euro crisis between 2010 and 2015, when sharp recessions and mass unemployment devastated southern Europe; the Covid-19 pandemic has snuffed out the tentative recovery. However, while Italy and Spain languish and France stagnates, Germany, the continent’s powerhouse (it accounts for around 30% of eurozone GDP) proved resilient. Global momentum boosted its export-led economy, helping to ensure that GDP expanded by an average of almost 2% a year between 2009 and 2019, according to the World Bank, compared with an annual 1.5% for the rest of the EU. And Germany looks poised to outperform its neighbours in the next decade too, not least because it is moving beyond its traditional strengths of manufacturing and engineering into new industries.

A big post-Covid-19 bounce

Germany is deemed to have dealt with Covid-19 better than most developed countries. However, the social distancing and lockdowns mean that its economy hasn’t emerged completely unscathed, with the OECD economic organisation of developed countries projecting that its GDP will fall 8% in 2020. A furlough scheme paying 60% of the salary of workers on zero or reduced hours has not been enough to stop unemployment rising to a five-year high of 6.2%.

Still, Germany has several advantages that will ensure that its economy bounces back more quickly than elsewhere, says Andrew Kenningham of Capital Economics. “Before the virus struck, Germany was growing much faster than other countries in Europe.” It is also much less dependent on consumption and tourism, two areas that have been hit particularly badly by the pandemic and are likely to be the last to recover, even after a vaccine is distributed. By contrast, the German manufacturing sector has experienced much less disruption to production and demand.

Another reason why Germany should recover relatively quickly is because of its “strong balance sheet”, says Kenningham. Germany is notorious for its puritanical distaste for government spending and debt (it is perhaps not a coincidence that the words for debt and guilt are the same in German). This meant that it went into the crisis with government debt equivalent to around 60% of GDP (compared with 85% for the UK, 98% for France and 138% for Italy).

While public debt has jumped over the last nine months, previous fiscal rectitude reduces the need for dramatic spending cuts and tax rises now and also provides scope for further support of the economy in 2021. The public sector isn’t the only part of the economy that has been thrifty. German consumers are far less inclined to splurge than their Anglo-Saxon counterparts. Household debt in Germany is worth 54% of GDP, compared with 89% in Britain.

Exports power emerging markets

German manufacturing is an important engine of economic growth, says Dr Steve Coulter, head of industrial strategy, skills and sustainability at the Tony Blair Institute for Global Change. This is because manufacturing accounts for a large portion of Germany’s exports, which in turn comprise 50% of GDP (compared with 30% of GDP in the UK). What’s more, many of these exports go to the fast-growing Asian economies, especially China. While the market for cars and machine tools, two of Germany’s biggest exports, “virtually dried up overnight” during the first wave of the pandemic, it has quickly recovered.

There is always the risk that German companies may suffer from any move away from globalisation, especially if “Chinese consumers decide to start switching to domestic brands”, says Coulter. Beijing is keen for domestic companies to shed their low-quality, bargain-basement image and start developing premium products, reducing demand for foreign goods. However, this is a bigger problem for the luxury-goods sector, dominated by the likes of France’s LVMH, than for German manufacturers. The reputation of German companies is based on their ability to “deliver quality goods that are both reliable and reasonably priced”.

German manufacturing excels at producing goods that target the “upper-middle part of the market”, aimed at those who want something more than basic quality, but don’t necessarily want to pay luxury prices. While this segment may be less prestigious than goods at the absolute top end of the market, it still leads to “surprisingly high margins” for firms that can supply the emerging middle class with popular products. Car companies, such as Mercedes and BMW, have been particularly successful in this context.

The Mittelstand: Germany’s backbone

A unique feature of the German economy is the extent to which it relies on the Mittelstand. This segment of the economy comprises a vast number of small and medium-sized firms, but also larger companies with a substantial degree of family ownership or influence that distinguishes them from traditional listed or private companies. According to the Deutsche Börse, the German stock-exchange operator, 58% Germany’s workforce is employed in the Mittelstand and it accounts for around 57% of economic output.

One of the main strengths of these firms is their ability to take a long-term view: they “spend a relatively high amount on research and development”, says Joerg Zeuner, chief economist at Union Investment. This reinvestment means that they can punch above their weight when it comes to staying “on the edge of innovation” and “developing new ideas”. They have remained competitive with global rivals in engineering and manufacturing. At the same time, they have increasingly been moving into new sectors, such as renewables.

Many people argue that smaller firms will always struggle to take advantage of economies of scale “and it’s certainly true that their relative importance to the German economy has slightly declined over the past few decades”, says Coulter. However, they still have several factors in their favour that bode very well for the future. While they compete fiercely between each other when it comes to selling products, “they are very good at organising collective training in order to ensure high labour productivity”. They also have good relations with their local banks, “which are much more forgiving than those in the UK”.

Biotech: a new growth sector

One area that demonstrates the durability of the German model is biotechnology. Germany “has quickly become one of the leading countries in Europe for biotechnology-focused companies”, says Anthony Ginsburg, managing director of GinsGlobal Index Funds. The revenue of the German biotech sector climbed from €3.7bn in 2016 to €4.9bn in 2019. The number of German biotech firms has increased to more than 660, including 23 listed ones, with the workforce rising from 18,000 in 2015 to over 50,000 today.

A key reason for this is the large amount of money, both public and private, invested in research. If you count all universities, colleges and non-academic research laboratories, there are almost 202 research facilities in Germany. The German government is also working hard to make sure that research breakthroughs don’t just stay in the laboratory, but are turned into marketable products. It has created more than 30 biotech hubs to encourage “close collaboration between research institutes, technology parks, regional political players and biotech firms” and they are already starting to make “a big difference”.

Germany’s status as a major player in the biotechnology industry has been cemented by its performance during the Covid-19 crisis. Not only is the vaccine developed by the Mainz firm BioNTech the front runner in the race to be the first to win regulatory approval, but Bosch and Roche have also successfully developed rapid diagnostic tests, with Roche’s antibody test showing a 99.8% accuracy rate. As of last month, there are 97 Covid-19 clinical studies under way in Germany – half of which have reached the trial stage.

The services sector is slowly improving

German firms may dominate engineering and manufacturing, but there is a general consensus that “the service sector is one of the German economy’s weak spots”, says Peter Dixon, senior economist at Commerzbank. This is partly because the focus on manufacturing has meant that the sector has been neglected.

Rules and regulations on anything from opening hours (good luck shopping on a Sunday) to licensing and permits, some of which date back to medieval times, are another problem. Finally, the government’s determination to balance the budget “has also limited the resources available for digital investment”. However, while “additional structural reform” is still required, [Germany’s] performance is often better than is popularly portrayed”. Pressure from the EU on Germany to open up its service sector to competition – by recognising foreign occupational qualifications, for instance, has worked. The number of foreign degrees acknowledged each year has risen to a record 36,000.

Germany’s financial sector also looks set to benefit from Brexit, in the short term at least. Britain is about to lose its “financial services passport”, which allows financial institutions to sell their products across Europe. This arrangement will be replaced with a weaker regime based on “equivalence”. As a result, says Coulter, “many banks that used to employ 10,000 people in London now typically employ 8,000 in London and 2,000 in... Frankfurt. With the EU “trying to make life difficult for London”, whether a deal is agreed or not, banks are likely to remain cautious.

A new workforce

Until recently there was concern that Germany’s future growth would be hampered by an ageing workforce. At present the average German woman has 1.57 children. While this is higher than some European countries (Italy’s fertility rate is just 1.34, for instance), it is still far below the replacement rate of 2.1. As a result, Germany’s population is projected to peak in around five years’ time before falling from 83 million to 75 million by 2060. The ratio of elderly and retired people is also set to increase compared with the working-age population, slowing down growth and raising the burden on public services.

The good news is that this trend is being reversed, or at least postponed, by the increased inflow of workers into Germany. While Angela Merkel’s decision in 2015 to let in large number of refugees on humanitarian grounds may have dominated the political debate, the more important story is the “large amount of economic migration into Germany”, says Union Investment’s Joerg Zeuner. Most of this has been from within the EU, “mostly Eastern Europe, but also some migration from Spain and even Greece”. Immigration has helped bolster the fertility rate from a nadir of 1.24 in 1994.

Whatever the origins of the migrants, “they tend to be younger than the average German, which has helped improve the demographic outlook for Germany”, says Zeuner. They also tend to be relatively skilled and in some cases have even helped found new companies. An excellent example of a company founded by first-and second-generation Turkish immigrants is BioNTech.

A buoyant property market

Germany’s strong growth outlook and more favourable demographics are good news for its property market, which has boomed over the last decade. While prices stagnated and even fell in real terms in the first two decades following the fall of the Berlin Wall, they appreciated by 123% between 2009 and 2019, according to Deutsche Bank.

This has led to a “lot of hand-wringing about property prices”, says Commerzbank’s Peter Dixon. But while there are “justified concerns” about valuations, “the simple fact is that in an environment of low unemployment and zero interest rates, property looks like a good place to be”.

Of course, a future “exogenous shock” could prompt a “correction”. However, the fact that it has “coped well with the biggest shock in living memory” this year suggests it will continue to boom. Even a reduction in bank lending, unlikely at present, won’t be enough by itself to “trigger a major turnaround”. Some ideas for investing in German property – and other promising areas – are in the box below.

What to buy now

The simplest way to buy into the German economy is to invest in an exchange traded fund (ETF) such as the Vanguard Germany All Cap UCITS ETF (LSE: VGER).

This ETF follows the FTSE Germany All Cap index, which aims to mimic the overall German stockmarket. The largest holdings are software company SAP, engineering firm Siemens and financial services company Allianz.

The ten largest holdings account for roughly half the fund. The ongoing charge is only 0.1%, and the fund trades at a price/earnings (p/e) ratio of 15.4, with a dividend yield of 3%.

If you want to invest in smaller German companies, consider the Xtrackers Germany Mittelstand & MidCap UCITS ETF (Germany: XDGM). This focuses on the German market, but excludes the 30 largest companies (these make up the blue-chip DAX index), leaving mostly mid-cap operators such as braking systems specialist Knorr-Bremse, cement manufacturer HeidelbergCement and medical-technology company Siemens Healthineers.

The largest portion of the fund’s holdings are in industrial companies, which account for a quarter of the portfolio. The ongoing charge is 0.4% and the fund trades on a p/e ratio of 15.7.

German biotech BioNTech (Nasdaq: BNTX) made headlines when reports were released earlier this month that its Covid-19 vaccine, which it is developing with pharmaceutical giant Pfizer, could be up to 90% effective in stopping infections, even in elderly patients.

Pfizer believes that it could have up to 50 million doses of the vaccine ready by the end of the year and 1.3 billion available by the end of 2021. It has already pre-sold 230 million doses of the vaccine (mainly to Britain and the US).

In the longer run, BioNTech is developing cancer treatments that use the patient’s immune system. While BioNTech currently loses money, it trades at seven times estimated 2021 earnings.

One of the oldest German biotech companies is Qiagen (Frankfurt: QIA). Although registered for tax purposes in Holland, its operational headquarters is the German city of Hilden. Qiagen mainly focuses on diagnostics and applied testing, including genetic research.

Over the last five years its revenue has been growing by around 7% a year. Among its many products is a portable digital Covid-19 antibody test that can process 30 samples an hour. Qiagen trades at 20 times 2021 earnings.

While Xtrackers FTSE Developed Europe Real Estate UCITS ETF (LSE: XDER) isn’t a pure-play on the German real-estate market, since it invests in real estate in a number of countries, around a third of its assets are in Germany.

It is trading at nine times trailing earnings and has an annual fee of 0.3%. An alternative in this field is Phoenix Spree Deutschland (LSE: PSDL), an investment trust that focuses on a diversified portfolio of 2,571 residential units and 141 commercial units.

These are spread over rental properties in the German capital, where there is a housing shortage. It is currently trading on 15.2 times current earnings, with a yield of 2.1%. It sells for an 18% discount to book value (the sum of its net assets).

A surge in coronavirus cases in Europe means that talk of a swift recovery is now a “summer memory”, says Peter Goodman in The New York Times. French prime minister Jean Castex this week acknowledged that “the second wave is here”, as governments across the continent tightened restrictions. Spain has declared a state of emergency in Madrid and instituted a partial lockdown there.

Economic gloom is spreading. France now expects activity to remain stuck at 95% of pre-pandemic levels for the rest of the year. Spanish business sentiment hit a four-month low last month. The pan-European Europe Stoxx 600 index is down 11% so far this year.

The changing of the guard

The common investment “trope” is that Europe is full of “old economy” firms while the US races ahead with technology, says Graham Secker in the Financial Times. Yet that idea is “outdated”. Banks and energy no longer dominate the MSCI Europe index. Indeed, the weighting of banks on European indices is now the same as the global average. The areas where European markets are “overweight” the global average today – healthcare, consumer staples and industrials – offer a “healthy mix of good, quality growth”. The European “leopard is indeed changing its spots”.

If the US market is increasingly a wager on tech, then Europe is “a bet on drugs”, says Stephen Wilmot in The Wall Street Journal. Five of its ten biggest firms are now drugs firms. Back in 2004 the top three Stoxx Europe 50 firms were all British: BP, HSBC and Vodafone. Today’s leading trio are Swiss: two pharmaceutical giants (Roche and Novartis) and Nestlé. Europe offers other “growth niches” as well, from French luxury goods to Danish cleantech (energy efficiency), says Reshma Kapadia in Barron’s. America’s S&P 500 has “eviscerated” other markets over the past decade, “returning 13.9% a year, on average” against 5.5% for the World ex-US.

Yet stretched valuations are giving Americans the “urge to do some portfolio globe-trotting”. If we strip out expectations about growth and just look at current valuations, then US equities are “priced to deliver” just 0.5% in annual real returns over the next decade, says Robert Arnott, the founder of Research Affiliates. Europe and Japan are offering real returns of “about 5%”.

A German anchor

Germany’s Dax has outperformed other European markets this year, falling by just 2.2%, thanks to the country’s export-led exposure to the strong Chinese recovery, says Anna Isaac in The Wall Street Journal. Analysts think German carmakers will also get a boost as the pandemic makes more people avoid public transport. In 2018 the debt of German non-financial companies was about 58% of GDP, compared with 84% in the UK and 141% in France. As Christoph Ohme of DWS Group puts it, strong public and corporate finances make Germany resilient in a crisis. It is a “stable anchor” for the world economy.

Are European equities being left behind? The pan-European Stoxx Europe 600 index enjoyed a strong start to the week on the back of the S&P 500’s new highs and the latest uptick in German business confidence (see page 11).

Yet a brief period of outperformance compared with the US index earlier this summer already appears to be over. The Stoxx Europe 600 has advanced just over 1% over the past month and is still down 11% for the year to date. By contrast, this year Japan’s Topix index has fallen 4% and the S&P 500 and China’s CSI 300 have gained 5% and 14% respectively.

The main factor driving the divergence has been the strength of technology stocks, Guy Foster of Brewin Dolphin told Tommy Stubbington in the Financial Times. “The UK has virtually no tech, and Europe doesn’t have that much.”

The underperformance is part of a long-term trend. As Tom Bailey notes on Interactive Investor, the MSCI Europe index has delivered a total return of 94.5% over the last ten years, compared with 311% from the American equivalent. Europe’s markets struggled after the financial crisis, not least because of rigid government budget rules that choked off growth.

But things are different in 2020, says a Goldman Sachs note. The German and French governments recently announced additional stimulus measures, while the €750bn European recovery plan will provide a dose of much needed fiscal solidarity with southern states, which have been hit hard by the pandemic.

An alternative to a pricey US

Wall Street money managers think that “Europe could be the antidote” to highly rated US stocks, say Ksenia Galouchko and William Shaw on Bloomberg. Rich valuations, election tensions and disputes with Beijing have initiated a “scramble for alternatives” to American assets.

This month’s Bank of America Merrill Lynch fund manager survey finds Europe is their favourite region. Then again, this wouldn’t be the first time investors have got excited about the old continent only for Europe’s bourses to disappoint.

Lacklustre energy and finance companies still play an outsized role on European indices, but investors shouldn’t underestimate Europe’s hidden growth stories, says Ian Conway in Shares.

From Dutch semiconductor specialist ASML and German software giant SAP to the continent’s world-leading pharmaceutical players, there are plenty of growth companies if you know where to look.

What’s more, European shares come with less “concentration risk” than US portfolios, which have become worryingly reliant on a handful of technology mega-corporations. Growth-hungry British investors need only look “across the Channel”.

Earlier this week, the European Union managed to agree a deal to issue joint debt to fund a post-coronavirus recovery package.

The deal wasn’t perfect or even especially impressive. But it was a deal.

Does it make European stocks worth betting on? Not in itself.

But something else does...

The US dollar looks like it’s heading lower for longer

The US dollar is one of the most important prices in the world.

Everyone needs dollars. So when US dollars are expensive, it means that money is tight across the globe.

US dollars have been expensive in recent years. That seems to be changing now.

The US dollar index (a measure of the dollar compared to the currencies of its biggest trading partners) has been slipping steadily in recent weeks and this week it’s taken a tumble. Meanwhile, the euro has been creeping higher.

What’s going on? Partly it’s the fact that Europe appears to be past the worst of the Covid-19 outbreak (obviously it could come back, but we’re talking as things stand), whereas the US still appears to be struggling.

Perhaps more significant is the collapse in US interest rates. Markets finally believe that the Federal Reserve has no intention of ever raising rates again until inflation is properly ignited. That would mean throwing the dollar to the wolves.

Remove a big chunk of the break-up discount from the euro (which is what this week’s agreement on a recovery fund has confirmed), and suddenly it looks it might be the more solid alternative currency bet.

I’m not suggesting that you start trading currencies – that’s a swift road to a high blood pressure count and a low bank balance.

But given the valuation gap between European and US stocks, now might be the time for Europe to play catch up and outperform the US. Indeed, European markets have been outperforming the US for a couple of months now.

I could point to lots of different bits of data, but here’s one very illustrative statistic for you. As Eoin Treacy of the excellent FullerTreacyMoney service points out, the combined value of all the shares on the tech-heavy US Nasdaq index "is now greater than the GDP of the whole European Union.”

It doesn’t mean the US market is going to hit a top any time soon. But it’s just yet another indicator of how expensive it is.

Will the US market start to worry about the November election?

Another event that might make Europe look more attractive is the US presidential election.

I can’t claim to be Donald Trump’s biggest fan. I wouldn’t shed any tears if he has to leave office after the vote in a few months from now.

However, I’m very intrigued by the market’s reaction to a Joe Biden presidency. What intrigues me is the apparent lack of reaction so far.

Betting markets (which are not infallible but are pretty reliable) reckon that Democrats will win both the Senate and the House. That means Biden should be able to push through his agenda. And one of the key things that he’s planning to do is to reverse the Trump tax cuts. So corporation tax will go back up, as will income tax.

Whether you agree with that or not, it’s not what you’d typically view as a market-friendly prospect. So why hasn’t the market reacted yet?

There are some good reasons. A Democrat majority might raise taxes back to where they were, but they’re also even more likely than Trump to spend a lot of money both on direct stimulus and on infrastructure and on getting people back to work.

Maybe a less abrasive president might improve relations with various global allies or even make relations with China a little less fraught (although don’t bet on it – I think that’s all too far gone).

Maybe after the lacklustre US response to the coronavirus they feel that it’s time for a change. And maybe – given a backdrop of rampant money printing – markets don’t really care who ends up being in charge at this point.

So it’s possible that markets are able to look beyond the tax rises and simply think that a Biden presidency would be the best outcome. And as I always say, politics is local – so maybe I just don’t know what I'm talking about, just like all the US commentators with weird misconceptions about what Brexit means.

That said, given what markets are like, it’s also possible that investors just haven’t quite mentally adjusted to the idea yet. So far, my sense is that Biden is in a “stealth” bull market. Investors may simply just be assuming that Trump will somehow retain the presidency come November.

So there’s the potential of a wake-up call – maybe an unnerving one – closer to the big day. And obviously there’s also the concern that the election won’t be cut and dried. Imagine repeating all that debate about “hanging chads”, only this time with Trump in the White House. Not fun.

Anyway – maybe the election will have no impact at all on the market, but I’m just raising it as another potential trigger for outperformance in Europe.

Plenty of you will have exposure to the eurozone already. But if you’re feeling particularly bold, John Authers notes in his Bloomberg newsletter that, according to Absolute Strategy Research, the “peripheral” countries tend to be the best catch-up plays.

In other words, when Europe is beating the US, the riskier European countries tend to beat the more traditionally investment-worthy European countries. So if you fancy a walk on the wild side, it might be time to break out your Italian and Greek ETFs again.

For more on the deal, see the latest issue of MoneyWeek magazine. You can get your first six issues free here if you subscribe today.

What’s happened?

German payments giant Wirecard, which processes tens of billions of euros in credit and debt transactions every year, filed for insolvency last week, with around €3.5bn of debts, following the exposure of an accounting scandal. The firm, founded in 1999 in Munich, has long been the darling of the German fintech sector. It boomed as demand for online payment-processing technology surged and the firm floated in 2005. In 2018 it replaced Commerzbank in the Dax 30 index of Germany’s biggest listed companies. Things were looking good and at its peak it was valued at €24bn.

But?

But short-sellers and journalists have long been sceptical about its financial reporting, in particular questioning the vast sums apparently spent buying obscure businesses in Asia. Last week, following years of sustained investigative reporting by the Financial Times, the auditors EY confirmed that they had identified a €1.9bn hole in Wirecard’s finances, triggering a 95% crash in the share price, frantic negotiations aimed at keeping the business afloat, and the arrest of Wirecard’s founder and chief executive, Markus Braun, on suspicion of fraud. He has since been released on €5m bail, while administrators are busy carving up the business in the hope of rescuing some value for creditors.

Was the implosion a shock?

It was certainly dramatic, but questions over Wirecard’s finances have been swirling for years. As early as 2008 the head of a German shareholder association published an attack on the business, alleging balance-sheet irregularities. Wirecard engaged auditors EY to conduct a special audit. But as profits grew rapidly, so did the questions – in particular over whether the firm was overstating the size of its Asian operations in order to inflate its share price and drive its highly leveraged expansion. In 2015 the FT began raising questions over Wirecard’s accounts. In 2016 anonymous short-sellers published a dossier of allegations. And over the course of 2018 and 2019 the FT was involved in a series of legal battles with Wirecard over its reporting on alleged malpractice at its Asian HQ in Singapore, as well as Dubai, the Philippines and Dublin – focusing on claims by short-sellers and insiders that Wirecard was fraudulently inflating its cash and profits and inventing customers.

What triggered the final collapse?

Under pressure from investors, last October Wirecard asked KPMG to conduct a special review. KPMG’s report, published in April, raised further concerns and cited “obstacles” to its work. In particular, it queried the existence of €1bn in cash balances. In June, German police raided Wirecard’s Munich offices. Then, in mid-June, two Philippines banks informed EY that documents supposedly confirming €1.9bn in cash balances with them were fakes. EY refused to sign off on the 2019 accounts and Wirecard was obliged, on 18 June, to announce that the money was “missing”. Braun resigned the next day and within a week he was under arrest and Wirecard had filed for insolvency.

This doesn’t look good for EY?

EY’s position is that it was conned along with everyone else. “We’ve established that third parties, with a deliberate aim to deceive, provided EY with false documentation in connection with its 2019 Wirecard audit,” said a spokesman. “The extent and sophistication of these suggest a large-scale international fraud at Wirecard.” EY says it identified false information during the 2019 audit and reported this to the relevant authorities at the time. But, it said, “even the most robust and extended audit procedures may not uncover a collusive fraud”.

Isn’t spotting fraud its job?

Ideally, yes. EY signed off Wirecard’s accounts for more than a decade before raising the alarm and it now faces a class-action lawsuit from more than 1,000 Wirecard investors seeking up to €1bn in damages. The big question, according to the FT, is why EY’s auditors apparently failed to confirm Wirecard’s cash balances with its banks for three years prior to the company’s collapse and instead relied on other documents and screenshots.

What about the German regulator?

It is now facing a probe by Brussels and multi-billion-euro lawsuits from thousands of investors. Felix Hufeld, head of the regulator, calls the Wirecard scandal “a complete disaster” and “a shame”. Yet he and the agency he leads, BaFin, failed for years properly to scrutinise Wirecard – and have instead pursued the firm’s critics. As early as the first shareholder attacks on Wirecard in 2008, the German authorities ended up prosecuting two of the people who had raised red flags for not disclosing their own positions in Wirecard stock. In January last year, after the FT reported on malpractice in Singapore, BaFin started investigating the newspaper for market manipulation. The next month, after police raided Wirecard’s Singapore offices, BaFin announced an unprecedented two-month ban on short-selling the stock. That’s a level of apparent “regulatory capture” that raises concerns over the whole German financial system.

Does anyone emerge with credit?

The Financial Times, obviously. Short-sellers deserve a pat on the back, too. One silver lining is that the affair could give a lift to the UK’s burgeoning fintech sector, says banking editor Katherine Griffiths in The Times. The Wirecard scandal means that fintechs globally are likely to take a knock as investors “question their sky-high valuations compared with the hard reality of how much cash is actually coming through the door”. But “Britain’s fintech sector should be one of the relative winners, due to its reputation for robust business practices and regulatory oversight”.

Markus Braun, who resigned last week as CEO of Wirecard, has now been arrested in Germany on charges of accounting fraud and manipulating the share price, says Simon Foy in The Daily Telegraph. He has been accused by authorities of “portraying Wirecard as financially stronger and more attractive for investors and clients” than it actually was (see story below for details). This comes after Wirecard admitted that €1.9bn (£1.7bn) of cash missing from its balance sheet “probably did not exist”. The company is “now scrambling to stay afloat” and is considering a “massive restructuring”.

The latest revelations have been a disaster for shareholders, who have seen Wirecard’s share price plunge by more than 80% over the past few days, says the Financial Times. But things may get even worse, since the scandal throws into doubt the entire performance of its payment-processing business, which was previously deemed the group’s key source of profits. Despite Wirecard’s talk of cost cuts and asset sales, lenders are unlikely to accept a delay in payments if the company “does not have much of a real franchise that generates real cash flow”. So there is a good chance that equity holders “will be left with nothing”.

Is Wirecard heading for insolvency?

It’s clear that there’s “little chance” of the company paying back creditors from its existing resources, says Liam Proud for Breakingviews. Still, lenders might as well be patient, since calling in the loans immediately “would tip the company into insolvency”. The best solution might be to extend Wirecard’s credit facility, giving the new boss James Freis enough time to “put together a financial rescue plan”.

Nonsense, says Chris Bryant on Bloomberg. Even if Freis manages to get banks to keep extending credit, there’s the issue of whether Wirecard “can hang onto its customers” after such an “epic failure” of internal controls and risk management. Indeed, the fact that there are “other providers of similar digital payment services” means that the company is “hardly irreplaceable”. Factor in the anticipated “avalanche of litigation” and regulators forcing Wirecard’s bank to close, and its days seems numbered. What’s more, given its behaviour, the question isn’t only “whether Wirecard can survive”, but also “whether it should”.

At least one creditor may have got out in time, says Margot Patrick in The Wall Street Journal. At the start of the year, part of SoftBank Group bought €900m worth of convertible bonds from Wirecard as part of a “strategic partnership”. However, instead of holding onto the bonds, which at the time were seen as providing a “shot in the arm” for Wirecard, it arranged for Credit Suisse to package them up and resell them to third-party investors. The bonds now trade for 12% of face value, “stranding investors and European private banks that bought [them]”.

Wirecard: the meteoric rise and fall of a fintech

The ongoing scandal is the latest chapter in the story of financial technology company Wirecard, says Kevin Granville in The New York Times. Wirecard was founded in 1999 and flourished in recent years as a provider of digital-payment services, prospering by “making contactless payments seemingly effortless for hundreds of thousands of merchants”. Customers included Apple Pay, Google Pay and Visa.

Praised as a “homegrown technology success” in Germany, it was propelled into Frankfurt’s blue-chip stock index, the DAX, in 2018. However, the very same year, Wirecard’s “meteoric rise” came to a halt, says the Financial Times. This is because an investigation by the FT examined its “suspected use of forged contracts”, while a report by a top law firm found “evidence suggesting Wirecard’s employees engaged in a pattern of book-padding and made up partners that couldn’t be found” to inflate profits and revenues. Last year Singaporean authorities raiding its Asian offices. The final straw came earlier this month, with banks in the Philippines, the supposed location of Wirecard’s “missing funds”, confirming that the company “was not a client”.

Wirecard’s collapse is a “vindication” for short-sellers, who have been questioning its accounting for years only to be threatened with lawsuits for “defamation”, say Paul Davies and Juliet Chung in The Wall Street Journal. It hardly helped that in 2019 Germany’s financial regulator BaFin took the“unusual step of banning short-selling against the company”.

The euro has been enjoying its longest rally since 2011, gaining 4.5% against the dollar since the end of May and eclipsing $1.1384 to the greenback. And European stocks have started to outperform US markets in the past few days.

Chalk it all up to better news. The continent has endured a painful slump, with the European Central Bank (ECB) forecasting an 8.7% fall in eurozone GDP this year. Yet things are on the mend,says Morgan Stanley. Purchasing manager indices and gauges of mobility and electricity usage suggest that the economy hit a trough in April. “The recovery is already under way.”

Long criticised for its frugal budgets, Berlin has rushed to the rescue on this occasion. Emergency measures to guarantee loans, cut taxes and boost electric-car uptake amount to €1.3trn, more than 35% of GDP. A generational shift has made German officials more pragmatic about borrowing than in past crises, says Derek Scally in The Irish Times. The European Central Bank also cheered markets last week by unveiling an expansion of its quantitative easing programme, whereby it buys bonds with printed money, from €750bn to €1.35trn. The move ensures continued downward pressure on financing costs for European businesses, says Jim Armitage in the Evening Standard.

The Franco-German plan to launch a common €750bn European bond also underpins the rally, says John Authers on Bloomberg. Markets hope that this step towards fiscal union will deliver a “Hamiltonian moment”, akin to the US federal government’s 1790 assumption of state debts. Common debts may ultimately pave the way for more EU-wide tax-raising powers, a crucial plank of genuine fiscal union. This crisis could prove a “historic moment in the European project”.

Germany’s chancellor Angela Merkel has finally acceded to a French plan to issue a common European bond, say Matthew Karnitschnig and Rym Momtaz in Politico. The proposed €500bn vehicle would borrow from financial markets and give grants to countries in need. The proposal is simple, says former European Central Bank (ECB) economist Lucas Guttenberg: “European bonds for EU expenditure”.

Some have gone so far as to speak of Europe’s “Hamiltonian moment”, says the Financial Times: a reference to the US federal government’s decision to assume state debts in 1790, which knitted together the young United States.

But for now, such talk is overheated. This plan falls far short of full fiscal union and could yet be watered down because of opposition from the “frugal four” of Austria, Denmark, the Netherlands and Sweden. Still, this “Eurobond trial balloon” is a powerful symbol of German commitment to the euro, says Katharina Utermöhl of Allianz.

Markets were cheered by the Franco-German announcement, which came as lockdowns were eased in many parts of the continent. The pan-European Euro Stoxx 600 index advanced by 3.7% last week. German investors’ confidence hit a five-year high in May.

The Stoxx 600 is still down 17% since the start of January, underperforming both the US and China. A crucial weakness is the region’s shaky banking sector. The Stoxx 600 Bank index has tumbled by an eye-watering 43% this year, note Jan-Patrick Barnert and Michael Msika on Bloomberg. Trading on just 0.4 times book value, Europe’s banks have never been cheaper, but few want to have a nibble. Negative interest rates, large loan-loss provisions and a shaky growth outlook are scaring off all but the bravest.

Tech sector eclipses banks

Staid European markets are weighted towards mature industries such as banking, carmakers and oil, while America has its high-growth tech sector to thank for consistent investment outperformance. Yet the rout in European finance means that the picture is changing, says a research note by Morgan Stanley. For the first time, technology is a bigger part of the European index than banks. Once accounting for one-fifth of the value of European shares, today the region’s banks make up just 5.6%, compared with 7% for technology.

Developed European markets trade on a cyclically-adjusted price/earnings ratio of 15.7, a bargain compared with America’s 26.8. With the ECB poised to provide yet more liquidity by expanding its €750bn bond purchase programme, that leaves European shares well placed to outperform when the recovery eventually arrives.

Is the eurozone at a turning point? The bloc’s GDP grew by just 0.1% in the fourth quarter of 2019, the slowest pace in almost seven years, says Elliot Smith for CNBC. Weak German manufacturing has weighed on wider performance and the coronavirus is more bad news for an economy where exports account for roughly 45% of GDP. Yet better survey data and sentiment indicators since the new year suggest that the slump could be bottoming out.

Fabio Balboni of HSBC points out that German wage growth has hit a 20-year high and unemployment is falling across the eurozone, so consumption could be in for a pick-up. That mildly positive outlook is buttressed by extremely loose monetary policy from the European Central Bank, which has cut interest rates and started buying bonds again last September.

For investors the most encouraging sign is a return to earnings growth. European businesses averaged around a 5% contraction in earnings per share during the first three quarters of 2019, according to Morgan Stanley. Yet the fourth-quarter earnings season looks encouraging, with earnings per share on track to rise 2.1% year on year.

And there may be better news ahead. Germany’s January Purchasing Managers’ Index expanded at it quickest pace in five months, reports Michael Searles for City AM. Throw in reasonable valuations, and the region’s equities are hardly a write-off.

“Only hours away” from another jury trial over its weedkiller Roundup, Germany’s Bayer has secured a postponement to allow room for “escalating settlement talks” to continue, reports Laura Kusisto and Ruth Bender in The Wall Street Journal.

This has raised hopes that Bayer may be close to settling claims related to allegations that Roundup causes cancer, which have already caused Bayer to lose three individual cases, leaving it liable for a total of $190.5m in compensation. A fourth adverse verdict could have handed the 42,000 plaintiffs involved so far “additional ammunition in settlement talks that have dragged on for months”.

A settlement won’t come cheap, says Fortune. Experts believe that settling the “tens of thousands” of claims, which could eventually rise to as much as 85,000, could cost around $10bn, with some even putting the costs at $13bn.

The lower estimate would imply $8bn to resolve current cases and $2bn set aside for future claims, including those related to diseases such as non-Hodgkin’s lymphoma “which can take years to diagnose”. There’s also the problem of trying to simultaneously negotiate with the various groups of plantiffs’ attorneys, “each with a sizable inventory of cases”.

The fact that Bayer’s shares rose by 4% on the news of the postponement suggests there is a risk that shareholders’ expectations “are getting carried away”, says Chris Hughes on Bloomberg. There remains a “real possibility” that the “saga” endures for longer than investors have anticipated if talks between the two sides break down. Indeed, given that Bayer still believes that Roundup doesn’t cause cancer, it could simply decide that it would be better off taking a chance on a trial if an acceptable figure cannot be reached.

The positive scenario

However, if a deal does end up being signed then shareholders could stand to do very well, as the chemical giant currently still trades at a “substantial discount” to its peers. The gap is worth “much more” than the settlement costs being discussed.

Just getting to a valuation matching its cheapest counterparts “would add about €20bn of market value, after deducting the estimated cost of ending litigation”, while a move toward the average of its peer group would see the market value rise even higher.

Shareholders may be relieved at the “fairly modest” settlement, say Ed Cropley and Aimee Donnellan on Breakingviews. Still, they are still entitled to be “hopping mad” at the fact that Bayer got itself into the mess in the first place by buying Monsanto (which originally developed the drug) for $66bn in 2018. A Bayer investor who bought shares when the deal with Monsanto was completed would still have lost nearly 20% of their stake today, while those who invested in other drug companies would have made big profits. Bayer CEO Werner Baumann “has a lot of work to do” to ensure that Bayer’s shares close the gap.