The current opportunity in European equities

European companies ≠ Europe’s economy 

There are plenty of reasons to be pessimistic about Europe - excessive government debt, low productivity, weakening demographics and geopolitical uncertainty to name just a few. However, the crucial thing for investors to remember is that the fortunes of companies listed in Europe are not determined by the macroeconomic picture in the region. 

Longer term equity returns are primarily driven by real dividend and earnings growth, not economic growth. Notably, two-thirds of benchmark revenues of European companies comes from outside the region. Indeed, the rest of the world remains an eager buyer of European goods and services which in many cases are best-in-class, competing against international peers on the global stage. 

The fluctuations in the best regional performers we have seen over recent decades (Japan in the 1980s, America in the ‘90s, China and emerging markets in the 2000s and the US again over the last 10+ years) could be an argument for reducing US exposure and allocating to more attractively valued regions, such as Europe. This is particularly so given the extent of US outperformance recently and the subsequent 30-year valuation discount of European stocks versus their US counterparts.

Positioning against uncertainty

As macroeconomic developments remain unpredictable, we continue to focus on identifying companies with sustainable dividend growth, which should provide resilience in uncertain markets and deliver outperformance over the medium to long term.

Our investment approach is to prioritise individual stock selection as the primary driver. We also seek to build a balanced 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. 

Technology stocks have experienced volatility following Chinese AI company DeepSeek's claims about developing efficient, low-cost AI model. While this is an evolving picture, we are looking closely at the implications for companies within our portfolio, which has an overweight exposure to technology - mainly in software. These are companies that are very cash generative and benefit from trends like businesses’ ongoing migration to the cloud. We continue to hold ASML despite the recent weak performance associated with lower demand from Intel, Samsung and China. On a 3– to 5-year basis we are confident about the company given the variety of and growth in use cases for leading edge semiconductors. 

We are also overweight companies in the consumer space, particularly some of the world-leading franchises listed in France such as Hermès and L’Oréal which have a long history of dividend growth. While the sector has been grappling with slower sales, hit by the property crisis in China, we do not anticipate that this market will remain challenging indefinitely. 

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. 

Opportunities in AI

Despite the macro uncertainty, there are ample opportunities in Europe, particularly on a like for like comparison with US peers. 

We see interesting opportunities related to AI and are excited to see the impact of more mainstream adoption of AI on a number of different stocks going forward. Our preferred way to play the AI theme is through ‘picks and shovels’ type companies such as Legrand. This French electrical business provides much of the ‘white space’ equipment for datacentres (power distribution units, switches, transformers, etc.).  

More broadly, the benefits of AI are likely to transform several industries. 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. Financial services firms could also see strong benefits.  

Cautious outlook

Given the uncertain macro backdrop and the evidence from the companies in which we invest, particularly those in the consumer space, we believe caution is still warranted. European stock markets have been lacklustre of late, with geopolitical concerns weighing on sentiment - particularly the potential impact of additional US tariffs. 

However, the most impacted sectors would likely be autos, spirits, and luxury. We do not own any of first two, and in the luxury sector our exposure is in high end names, where tariffs are unlikely to change much in terms of end demand. 

In this environment, we will continue to focus on attractively valued companies with strong balance sheets that should be resilient, and able to grow dividends even in a more difficult environment.