Are European stocks the next big opportunity as economic recovery takes hold?

European equity indices have not bounced back in the same way as their US counterparts, indicating there is room for gains, especially as European officials have taken strong measures to boost recovery

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French freerunner Johan Tonnoir practises on Trocadero Plaza with the Eiffel Tower in the background in Paris on May 11, the first day of France’s easing of lockdown measures that had been in place for 55 days to curb the spread of Covid-19. Photo: AFP

Published: 8:00pm, 12 Jun 2020Updated: 10:28pm, 12 Jun 2020

A wave of optimism has washed over global equity markets in the past few weeks as investors cling to supportive policies and the easing of lockdown measures around the world.

The benchmark S&P 500 equity index was recently back in the black, briefly, for the year. It wasn’t quite a return to its February peak, but a remarkable achievement nevertheless, given the economic impact of the coronavirus pandemic and a highly charged political environment. Meanwhile, European equity indices are still 10 per cent below the levels at which they started the year.

Why has Europe fallen behind the United States, and does this create an opportunity outside America as the economic recovery takes hold?

The strength of the US market performance so far is largely a function of what you get when you buy US versus European stocks. The US equity market is viewed as being relatively defensive thanks to a higher weighting towards the technology sector. Technology companies account for a little over 25 per cent of the S&P 500 and this sector has gained close to 12 per cent this year, helping to offset the weakness in the more cyclical sectors.

Contrast this to the MSCI EMU index, which covers the single currency block in the euro area. Here, the technology sector is less than 12 per cent of the index, while those most reliant on strong economic activity to perform well – the industrial, non-essential consumer goods and financial sectors – make up 44 per cent of the index.

Workers complete an electric car body at the assembly line at a Volkswagen plant in Zwickau, Germany, on February 25. The European index is dominated by sectors reliant on strong economic activity. Photo: AP

In broad terms, the European equity market is more cyclical than the US market, meaning that it is inevitably late to the party as wary investors need more evidence of an economic recovery.