European equity outperformance: stop or else ?

The strong outperformance of European equities (Eurostoxx large) between the beginning of September 2022 and the beginning of March is quite impressive. In local currency, the EuroStoxx outperformed the S&P500 by almost 19%; the outperformance is even more marked in euro (25%) due to the appreciation of the euro over the period.

On a technical level, this was the result of 3 phenomena; a rise in relative P/E, relative EPS and the euro vs dollar.

On a fundamental level, the outperformance was due to a relative increase in real macroeconomic surprises with the risk of recession in the Eurozone declining, inflation surprises declining slightly more than the US and relative political risk declining. In addition, it should be remembered that the European market is more exposed to the global cycle and has a higher beta. In this context, the Chinese recovery theme (since the abandonment of zero-covid in early December) has benefited it more.

This outperformance also more directly reflected sector effects. 90% of the outperformance excluding the currency effect since the beginning of September is explained by a selection effect (i.e. within the same sector, European companies outperform their American counterparts). The allocation effect (linked to the difference in sector weights) was very weak; it only concerned luxury goods, industrials and materials, and even in these sectors, it was not very significant.

The selection effect was fairly widely spread; it concerned more particularly automotive stocks (Mercedes), luxury goods (LVMH), financials (Banco Santander, Unicredit, Allianz), industrials (Siemens), and even technology stocks (SAP).

What next?

There are reasons to be sceptical that the European market will continue to outperform. Why is that?

First, because the potential for real macro and inflation surprises is running out in the eurozone. Second, because relative political uncertainty is unlikely to improve further given the situation in Ukraine.

Moreover, the outperformance over the last 6 months is already substantial compared to similar phases in the past 35 years, comparable in magnitude if not in duration (see table below).

Phases of significant outperformance of Eurostoxx vs. S&P 500 (in price and local currency)

Beginning End Eurostoxx outperformance vs. S&P 500
(in local currency)
Eurostoxx outperformance vs. S&P 500
(in common currency)
Euro vs USD Length (months)
29/01/1988 20/04/1990 34% 35% 0% 27
18/12/1992 12/05/1994 45% 31% -9% 17
25/11/1996 04/08/1998 36% 16% -15% 20
05/10/1998 07/03/2000 50% 20% -20% 17
12/03/2003 11/04/2007 42% 73% 22% 49
18/06/2012 28/12/2012 15% 21% 5% 6
12/11/2014 13/04/2015 24% 5% -15% 5
06/07/2016 05/05/2017 16% 15% -1% 10
Average 33% 27% -5% 20
Median 35% 21% -9% 17
01/09/2022 28/02/2023 19% 27% 7% 6

Source : Datastream, Les Cahiers Verts

In addition, the discount to the US has narrowed significantly and the risk premium has compressed more sharply in the Eurozone in recent months.

At the same time, there is a form of optimism on the part of analysts regarding short and medium-term expectations for the Eurozone. In particular, the momentum of downward EPS revisions has been weaker than in the US and Japan.

This is despite the fact that margins have not really adjusted (except slightly in the Big Caps), unlike in the US and Japan.

In total, European analysts’ forecasts assume EPS growth of +2% on average over 2023, whereas a slight contraction hypothesis seems more plausible to us as it stands: the still satisfactory growth in turnover would be offset by a compression of margins and a slight rise in the euro.

All other things being equal, it is preferable to have a more diversified geographical allocation over the next few months or, at the very least, a smaller allocation to European equities.