Europe is not a business backwater

Welcome to the first free lunch of Sunday. I’m Tej Parikh, an economics editorial writer, occasional columnist and Alphaville blogger for the Financial Times.

Economists, investors and journalists alike like to come up with concise explanations to help understand the global economy. In this communication, I will test them by presenting alternative narratives. Why? Well, that’s interesting – and because it avoids confirmation bias.

Let’s start with unpopular European stocks. We’ve read about how booming US stocks are leaving transatlantic equities well behind, while European industry faces some headwinds. It left Europe with an image of an outdated business. Are mainland companies really that bad? Here are some rebuttals:

European stock markets

The US S&P 500 Index is in the midst of an artificial intelligence-led boom. The “big seven” technology stocks make up about a third of the index and have a market capitalization greater than the combined market capitalization of French, British and German exchanges. Technology stocks account for only about 8% of the Euro Stoxx 600 index.

But here are some perspectives. Excluding Nvidia from the S&P 500, its total returns have been lower than those of the euro zone equity benchmark since the start of the bull market in late 2022.

There are several explanations for this data point. First, the bull market in the S&P 500 largely reflects bets on artificial intelligence, specifically Nvidia. Second, despite fewer tech stocks and slow economic growth, Eurozone stocks are actually doing quite well. (“S&P 499” still includes the remaining six “Magnificent”).

Jeffrey Kleintop, chief global investment strategist at Charles Schwab, who marked the chart above, also noted that the euro zone’s forward price-to-earnings ratios trade at a historic discount to the S&P 500, providing further support for European valuations. The rise creates space.

Regardless, European stocks clearly have potential appeal. Where does it come from? Goldman Sachs calls the continent’s major listed companies “granola.” The abbreviation covers diversified international companies in the pharmaceutical, consumer goods and health sectors. Together they account for about one-fifth of the Stoxx 600 Index.

Their performances against the Seven were divisive until recently. The S&P 500 (which derives about 70% of its revenue from the United States) was shaken by the election of Donald Trump.

They are not corporate weaklings. Novo Nordisk makes the popular Wegovy weight loss drug. LVMH is unparalleled among luxury brands. ASML is the global expert in chip design. Nestlé is an international staple.

Their ending in 2024 is not good. Novo Nordisk’s latest obesity drug test results are “disappointing”, LVMH Moët Hennessy Louis Vuitton is suffering from weak demand in China and tough macroeconomic conditions are eating into Nestlé’s profits. Still, they are mature, broad-based businesses with global reach, low volatility and strong earnings – some of which are now undervalued.

But Europe is more than just granola. Other companies are competitive in various sectors, including technology: Glencore, Siemens Energy, Airbus, Adidas and Zeiss, among others.

Small publicly traded European companies also tend to outperform their U.S. peers. About 40% of U.S. small-cap stocks had negative profits, while in Europe the figure was just over 10%. In the United States, the winner-take-all dynamic may be stronger, with tech giants siphoning capital and talent from smaller companies. (This should not diminish Europe’s real scaling challenge.)

European companies also rely more heavily on relationship-based illiquid financing, unlike the United States where listed equities dominate. This may encourage long-term corporate governance in Europe, but also highlights the challenge of comparing U.S. and European stock performance (liquid stock flows are not at the same level).

Regarding Trump’s tariff threats, it is not entirely a disaster for European companies. Only 40% of the Stoxx 600 group’s revenue comes from the African continent. (For good measure, Frankfurt’s DAX index rose nearly 20% last year, outperforming its European peers, despite Germany’s economic downturn.) A stronger dollar will also boost earnings for European companies with significant U.S. sales.

All in all, the excellent returns on U.S. stocks don’t mean that European companies are bad. Instead, investors are willing to pay a premium for access to artificial intelligence (and Trump 2.0) — something that seems harder to justify.

Beyond the value proposition, there are a few catalysts that could attract more investors to European stocks: disappointing artificial intelligence results, lower interest rates in Europe, Trump risks, and further stimulus attempts from China.

And even if its public companies make a lot of money outside Europe, there are benefits at home.

First, in the face of unprecedented shocks, the European economy can be said to have demonstrated agility and resilience, such as no longer relying on cheap Russian energy. Total manufacturing output has been essentially unchanged since the start of Trump’s first term (pharmaceuticals and computer equipment made up for the shortfall in auto production). The so-called peripheral economies of Europe are also doing better.

Then there are the long-term domestic profit and financing prospects. Despite the political instability facing France and Germany, the growing urgency for policymakers to address weak productivity growth in the euro zone has at least led to more encouraging discussions about reforms. There is growing consensus on the need for a true capital markets union to drive scale, deregulation to support innovation, a more pragmatic approach to free trade and China, rethinking Germany’s debt brake, investing in digitization and lowering energy costs. Mario Draghi’s report on European competitiveness added momentum.

America’s financial, innovative and technological advantages are unquestionable. Whether Europe can actually implement important reforms is another matter. However, the relative surge in U.S. stocks, thanks to their vast pool of liquidity, tech expertise, and artificial intelligence, has obscured advantages for European public companies that I, at least, did not fully appreciate. The continent is home to diverse, resilient international companies with proven use cases (and AI is still looking for such companies). This is a solid platform for investors to leverage and for policymakers to build on.

What do you think? Please leave me a message at freelunch@ft.com or @tejparikh90.

Thoughtful

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