Companies in Europe still offer compelling opportunities

Fidelity European Trust portfolio managers Sam Morse and Marcel Stötzel share their outlook for 2025 and provide an insight into how they are looking to position the portfolios against an evolving macroeconomic backdrop.

We remain cautious in the near term. Markets are still expensive, and the pace of rate cuts from central banks could disappoint, with inflation ticking up again and yields also rising. This means that refinancing poses a significant challenge for many companies next year. On top of this exporters face headwinds from higher US tariffs, although we are underweight areas like autos and spirits which could be more heavily affected.

We could see the market react positively if actual tariffs are less severe than expected. On a strategy level our luxury holdings are the most exposed to tariffs. However, we are defensively positioned within this category - more towards top end luxury - where customers are more price insensitive, meaning tariff costs can be passed on relatively easily to consumers. If inflation in Europe is subdued, this will allow for further rate cuts, while fiscal stimulus in the US and China could be a positive for European exporters going into 2025.

Negative surprise potentials are essentially the flip side of the above - high tariffs and deepening ‘trade wars’, and sticker than expected or even rising inflation. Geopolitically, unexpected developments in Ukraine or the Middle East could pose risks. Europe, as a net energy importer, is particularly vulnerable to energy price spikes that could occur from any worsening Middle Eastern crisis.

As macroeconomic developments remain unpredictable, we continue to focus on identifying companies with sustainable dividend growth, which can ensure resilience in uncertain markets and deliver outperformance over the medium to long term. We also seek to build a balanced, benchmark aware portfolio and look for the best companies across sectors, favouring stocks that have strong balance sheets, pricing power and a strong competitive position within the areas that they operate. And however gloomy some of the macro factors affecting Europe are, some two-thirds of benchmark revenue comes from outside of Europe, meaning we have far greater exposure to growth opportunities in other regions than many would assume.

There are ample opportunities in Europe, particularly if you performed a like for like comparison with US peers. We see interesting opportunities related to Artificial Intelligence (AI), including semiconductor equipment businesses as well as less obvious ‘picks and shovels’ plays on the theme. Such as stocks which provide critical infrastructure for data centres. Some European software names are in the process of developing AI packages that could accelerate revenue growth and answer critical business questions that will bring significant value to customers. Data-based drug discovery, leveraging cloud and AI advances, could help some pharmaceuticals to deliver transformative medicines.

Our investment approach is to prioritise bottom-up stock selection as the primary driver of returns rather than making top-down calls or sector allocation bets. We remain slightly overweight IT, given the number of stocks here which meet our criteria in terms of being sustainable dividend growers with good quality-growth characteristics. Conversely, we remain underweight industrials. We struggle to find capital goods names that meet our selection criteria, while many look to be on peak earnings, with the potential for cycle downturns.

We remain cautious overall, given the demand headwinds some stocks in our universe continue to face (notably in the consumer space) but continue to believe that through our disciplined stock selection process, we can deliver outperformance over time for clients.