- Stoxx 600 hit a new record this month
- Just a handful of companies are driving the index
Europe’s equity markets have outperformed expectations so far this year but, as in the US, growth has been driven by just a narrow group of companies. These European giants were strong enough to pull the benchmark Stoxx 600 index to an all-time high last week, although this is not a sign of growth overall for the continent.
The gain is more "stock-specific than macro-driven”, said Maximilian Uleer, Deutsche Bank’s head of European equity and cross-asset strategy. It can largely be attributed to the performance of just four major companies – Danish pharma giant Novo Nordisk (DK:NOVO.B), Dutch chip-making equipment supplier ASML (NL:ASML), French luxury group LVMH (FR:MC) and German software specialist SAP (DE:SAP). They have been responsible for more than half of this year’s gains. The expanded group (the cutely named 'Granolas') also includes GSK (GSK), Roche (CH:RO), Novartis (CH:NOVN), L’Oreal (FR:OR), Astrazeneca (AZN) and Sanofi (FR:SAN). Overall, they have contributed 60 per cent of the Stoxx 600’s 12-month gain of 12 per cent.
Although they are more diverse in terms of their activities than the so-called Magnificent Seven tech stocks driving the S&P 500 index higher, they are just as concentrated, representing around a quarter of the market, Goldman Sachs’ Europe equity strategist Guillaume Jaisson said.
They’ve also matched the returns of the US tech giants over a three-year period but have been more impressive on a risk-adjusted basis, as the shares have been far less volatile.
As with the US, though, there are concerns over whether such a narrow band of companies can continue to prop up markets.
The macroeconomic picture for the eurozone has improved since investment banks were making their forecasts at the end of last year. Gerry Fowler, head of European equity strategy at UBS, has revised his year-end target for the Stoxx 600 up to 450 from 410 previously, as a 'soft landing' scenario for the economy became more apparent. The index sat at 495 at the time of publication.
Forward indicators such as the OECD’s composite leading index and PMI surveys are on upward trends even without any fiscal or monetary stimulus . “When you look at the Stoxx 600 history, these phases of expansion tend to be very good for the equity market,” he said.
A mighty fall?
Despite this, Fowler still expects the index to fall back from its current level by the year-end as earnings remain weak. “Even though we’ve seen the market rising… and people are getting more confident in the medium to long-term future, the 2024 earnings per share (EPS) growth estimates are still coming down even through earnings season, where some companies are doing very well, but many aren’t,” Fowler said. By contrast, the members of the Magnificent Seven are expected to increase earnings this year, excluding Tesla (TSLA).
So far, 55 per cent of Stoxx 600 companies have reported fourth-quarter earnings and, on average, EPS is down 11 per cent year on year, according to JP Morgan. This compares with a gain of 7 per cent for S&P 500 companies. European firms were also marginally more likely to miss market expectations.
UBS is forecasting a contraction in EPS of 3 per cent from Stoxx 600 companies in 2024, which is “not a million miles away” from current market assumptions of 4 per cent growth. “But it’s still 7 per cent of downgrades that we think the market will need to digest through the rest of the year,” Fowler said.
The relatively benign earnings, macroeconomic and interest rate expectations so far have contributed to the lowest level of market volatility since 2017, Deutsche’s Uleer said.
Given the loftier expectations around the Granolas, does this make them more susceptible to a crunch if markets become less predictable?
Fowler points out that in sector terms, pharma and semiconductors are currently the most crowded, reflecting the heightened interest in ASML and Novo Nordisk. Both companies’ shares trade well above their long-run valuations on a price/earnings basis.
Yet Goldman’s Jaisson argued that, in past periods of volatility, this group had proved to be “well insulated relative to the market”. Further, these companies are highly exposed to the US, particularly the pharma giants. ASML is a standout because it largely sells its lithography machines, used to make advanced semiconductors, to Asian buyers, across China, Taiwan and Korea, although the US is pushing it to stop selling to China.
The Granola group overall trades at 20 times earnings – a 60 per cent premium to the broader European market, but a discount of 30 per to the Magnificent Seven.
“These companies exhibit qualities that we expect to predominate in the forthcoming cycle: strong earnings growth, low volatility, high and stable margins, strong balance sheets, and sustainable dividends,” he said.
