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.
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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.
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