European equities: Earnings momentum, reform tailwinds and three themes driving opportunity

Hugo Cryer (HC)

Hi, everyone. I’m Hugo Cryer, client portfolio manager at Janus Henderson. I’m here with Robert Schramm-Fuchs, who is head of the European equity large cap team at the firm and a portfolio manager across the strategies. Today, I’m going to be putting a series of questions to Robert as we enter the second half of this year, specifically, the five most common questions that we’ve been receiving from clients over the last couple of weeks or so. So Robert, welcome.

I’m going to start with a very broad question in terms of your outlook for European equities as we look forward, which I appreciate is a very difficult question given how dynamic market narratives have been in recent weeks, with the Iran war and often swinging between risk on, risk off. But I think your one-minute overview, there would be a very useful place to start.

Robert Schramm-Fuchs (RSF)

Yeah. Look, I think our outlook for the year, second half of this year, is actually quite positive for Europe. Now the restart of military activity in the Iran war has not helped, but it’s also not a huge disaster as it stands. The market is becoming a bit desensitised to the whole conflict. You can see it in the oil price here as it’s come up a little, but not to any levels where it would present a big challenge, a big problem for our positive outlook for Europe.

Otherwise, we have a fairly benign inflation outlook that allows policy makers to go easy on the rate hikes. We have a strong end demand environment, in particular driven by our main trading partner in the US. And so that helps Europe as an export-oriented market. And earnings revisions for Europe have been quite strong. And if anything, the European index has actually trailed these earnings revisions paces this year, which is a nice difference to especially last year.

HC

Yeah, that’s great. And I think one of the interesting dynamics that have been shaping the market at the moment has been that sort of rotation between sectors and factor exposures. The momentum unwind, for example, that we saw. And also the recent pullback in AI winners for example. So how are you thinking about that as you sit here today?

RSF

Yeah. It’s very difficult to have a precise crystal ball and how long this momentum unwind can go. But I would just point out that some of the correlation indices we follow at the moment shows a record degree of dispersion, record low correlation priced into the market. This tends not to last. It tends to mean revert, and when it mean reverts it usually does so reasonably violently.

And so, for the very short term, in contrasting with our in general bullish outlook for the second half of the year, this is a sign of caution for us. And I would point out a lot of similarities actually, to July, early August of 2024 when we similarly had mild CPI data, a significant counter momentum rotation in options expiry immediately after, and then a sharp, after a very low correlation,  a sharp correlation in a more or less combined sell off across the market. It was over in a few weeks, but it was, it ruined people’s summers.

HC

Thank you Robert, maybe if we just shift gears a little bit here, one of the very interesting dynamics that have been driving European equities, really from a narrative perspective from towards the end of 2024 has been the reform agenda. And we obviously had the most recent announcement from Germany of the reform package in early July. So I think would be really useful to hear your thoughts on how that’s progressing more broadly?

RSF

And it’s actually a great coincidence. I met the ex-German finance minister this morning for breakfast. So it was a great meeting because I think what’s going on in this pension reform is quite revolutionary and it deserves highlighting. What is going on is that for the first time, Germany moves away from a purely transfer based pension system to one that actually creates a capital stock, where payers at the moment are incentivised. Yes, but also there’s a mandatory element to it where they need to build capital stock for their own retirements. And so that of course is very helpful A) that it relieves some of that future demographic pressure because we know the demographics will get worse into the 2040s before it finally goes the other way. So the pension system and the associated costs and competitiveness questions that you have would have gotten worse otherwise for another 20 years.

So that’s positive. The other positive element I see is that we have a really meaningful reform. There’s lots of little bits associated with it as well. And so, it is the first time, I think, that a European government has listened to its expert commission, and they said, we take 100% of the measures proposed from the experts and implement them.

So I think that deserves highlighting and why we’ve been over the last year, speaking a lot about potential European reforms under the impression of the Mario Draghi report from late 2024 and that initial reform momentum in Europe, unfortunately that has stalled. But Germany seems to be re accelerating in its reforms, and I think it’s doing the exact right things here.

HC

It’s really encouraging to hear. Thanks for that. I think with in particular that that kind of question and those comments in mind, but also the discussion so far. I think it’d be really helpful at this point just to kind of hear and again, appreciating how difficult this is to comment on, given how dynamic the market is, but how you’ve sort of been positioning the portfolios and certainly where you’re seeing the most opportunities as you sit here today?

RSF

Yeah. So I think for us, there’s three areas of opportunity where we want to pick from in particular. And that represents sort of the bulk of our portfolio as it stands today.

The first one is, of course, high-tech, leading-edge tech, where Europe does have some very good companies. And now, of course, there’s a question of how long does this last, how long can the AI and the semiconductor cycle last? But it is an area where Europe has some very good companies and some are on very attractive valuation multiples, as a result of that recent rotation.

Now the second part where we want to pick from is we see and we have seen that now for quite a few years. It started under the first Trump administration, intensified under the Biden administration, this strategic competition for resources. It originated from the US-China trade conflict and then, of course, went from semiconductor export restrictions to rare earth minerals and so on. And now we have the Iran war adding another element to it where we realised that also in oil and gas, not every molecule is the same and that it matters where it’s coming from and how reliable that source of supply is.

And Europe had experienced it before with massive reliance on Russian supply, so that geostrategic competition for scarce resource is a topic that is built up now over 7-8 years, and it seems to only be intensifying. And again, we are in a fortunate position in Europe that we have some of the leading OE companies. Be that in mining, be that in oil and gas. But we have a lot of the leading equipment suppliers. And so given that these sectors have been starved of capital investments for many years, in the case of oil and gas, almost a decade in the case of mining for more than two decades, we are seeing a resurgence in capital investment in these sectors, which gives us a nice second derivative play that we can put into the funds.

And then the third angle of where we are picking our stocks from is that European reform /policy support momentum. And wherever, and it sort of wanders over time, the priorities of politicians shift. But wherever it lands on which receives a disproportionate amount of benefit from it. Be that in terms of protecting markets via quotas, via tariffs. Be that in terms of direct subsidies, renewable energy and so on. Presents another area for us of investment opportunity because it is abnormally high growth versus the rest of Europe. And I think just to conclude on that, we know actually in our relevant universe of European large cap stocks, we have the majority of revenue no longer coming from Europe but from outside of Europe.

And so, these three themes help us to pick stocks that should have earnings growth well in excess of European GDP.

HC

That’s great. Thank you. I think just time possibly for one more question here. I think, you know, we recognise clearly there are challenges in Europe but also clearly lots of opportunities as you as you’ve discussed. But we are seeing interest from, you know, clients still that are looking to diversify, in particular their quite concentrated exposure in the US and kind of tech exposure. So is that something from your perspective that you’re observing as well?

RSF

Yes, definitely. I think we see it in our own business, and I think the number of interactions, the number of enquiries we’re having with investors outside of Europe has increased quite significantly in recent months. So I take that as a positive sign. And I think that whereas we had one start at the end of 2024, early 2025, I think that re-engagement now given the earnings momentum in Europe, given that the index is undershot, its earnings momentum I think is of a durable nature.

And given that what I just said to the prior question, the majority of revenue actually now comes from outside of Europe in our large cap universe, we are getting to these valuation discrepancies where European stocks are just so much cheaper than they are directly comparable counterparts, which are listed elsewhere. But these stocks have become so comparable. If you had a blind test and get the P&Ls and the balance sheets of these stocks listed in Europe versus the competitors listed, for example, in the US, it wouldn’t really make sense why there is such a valuation discrepancy.

And you wouldn’t be able to identify which one is the European company, which one is the US company.

HC

Thank you Robert. Really interesting insights and discussion. And thank you to all of our listeners for taking the time today.