Equity Strategy Monthly: European Top Picks & Outlook for Q2

At the start of the second quarter, check your assumptions. Rallies in most sectors still leave plenty of stock opportunities while upheaval in the financial sector hasn't pushed bank stocks into the bargain bin

Michael Field, CFA 4 April, 2023 | 8:30AM
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Euronext Paris

After a relatively peaceful start to the year in which equity markets rose pretty steadily, investors were taken aback by the events surrounding the banking sector in mid-March. The near-collapse of European banking giant Credit Suisse came alongside numerous banking collapses in the US, evidence for some investors that systemic problems exist in the system. Although equity markets rallied again toward the end of the quarter, it's clear that market confidence has taken a dent.

Economically, Europe is in a tough spot. Growth is low, inflation remains high, and interest rates are still increasing, with the ECB indicating that more rate rises are on the cards this year. Pressure is mounting on businesses as the cost of debt rises. Equally, consumers are facing rising mortgage costs, combined with pay increases that have largely not been keeping up with high levels of inflation.

ECB & BOE interest rates

Despite these challenges, the equity market is trading relatively close to our fair value estimate, with only about 5% upside from here. Confidence is key, and we believe that for the market to increase from here, we will have to see some rays of sunshine to convince investors that the economy will be in a better place by year-end. A positive corporate earnings picture should help, as should falling inflation, If this continues to occur in the Eurozone.

European price/fair value chart

As a region, Europe outperformed other equity markets in the first quarter, rising close to 5% over the period. On a valuation basis, Europe now trades at a premium to North America, a situation we have not seen in several years, with the two regions trading above the global average.

Price/fair value in major world regions

Where Was the Action?

Technology, industrials, and consumer cyclicals were some of the sectors with large positive moves, each rising by double-digit percentages, though this ultimately amounts to a catching-up, leaving 12-month returns for almost all sectors at a broadly similar level. The one exception to this is the energy sector, which is no longer experiencing the strong tailwind of high energy prices, but is not collapsing either, falling less than 2% over the quarter, and still up almost 20% over the past 12 months.

Despite some of these large moves, most sectors look reasonably attractive on a valuation basis. While the sands have shifted, every sector across our coverage continues to trade below our fair value estimate – an unusual, but welcome scenario. Sectors such as industrials are very close to their fair value estimates; others, like consumer cyclicals and communications, look particularly attractive at the moment. Given the upheaval in the European banking sector in March, one might have expected that valuations here would be rock bottom – instead valuations have largely held up, although an attractive discount remains.

sector valuations

Ultimately, we see stock opportunities across our coverage universe. In all but two sectors, 5-star stocks are present. In fact, across our entire coverage less than 10% of stocks are rated as overvalued. For investors looking for a bargain, there are many to be found.

Star ratings histogram by sector 

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Michael Field, CFA

Michael Field, CFA  Michael Field is Morningstar's European Equity Strategist

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