28 months later: are European equities back on investors’ radar?

It’s been a tough couple of years for pan-European equities. A combination of political worries, including Brexit, and weak economic growth means many investors have shunned the asset class. Equity investors have tended to favour the US instead.

However, there are tentative signs of renewed interest in Europe from investors. The chart below, which uses data from Morningstar, shows that there were positive flows into actively managed European equities in June. This comes after 28 consecutive months of flows out of active funds in the asset class.  

What could be sparking this renewed interest? Firstly, Europe has had relative success in containing the coronavirus. While a number of countries – notably Italy – were badly affected in the early months of the pandemic, the strict lockdown measures ordered by governments have been successful in slowing the spread of the virus. Economic activity, including international tourism, has restarted in many countries.

Perhaps more significantly, the response of the EU has helped build confidence. Individual countries supported households and businesses via various methods, but the €750 billion EU recovery fund is an important breakthrough. It will see the European Commission borrow on capital markets and a €390 billion programme of grants to member states who were economically weakened by Covid-19.

• For more on the recovery fund, see EU takes giant leap and edges toward fiscal union

The scale of the recovery fund was a boost to markets when it was first proposed. The fact it has now been agreed, albeit after protracted negotiations, shows how the European authorities are capable of a credible and co-ordinated response. This is a positive step that may have surprised some observers and asset allocators.

Clearly, the outlook is uncertain, particularly as regards the spread of the virus. Clusters continue to emerge and the prospect of a second wave cannot be ruled out.

However, Europe’s response to the virus so far may be a factor in attracting investors to the region’s equities, both in terms of containment and collective action on the recovery fund. By contrast, the US faces new lockdowns in some states and an uncertain presidential election this autumn.

At the same time, valuations in Europe remain attractive compared to the US. As of the end of June, the cyclically-adjusted price-to-earnings ratio for Europe ex UK was 18.2x and 12.7x for the UK, compared to the US on 27.7x.