European Equities: A Worth Noting Opportunity For Diversification And Value

European inflation is steadily declining, and stock valuation appears relatively reasonable
Germany’s fiscal reforms are expected to improve Europe’s long-term economic outlook
Markets may experience volatility due to US policies and global uncertainties

Global markets swung sharply amid oscillating US tariff policies. While the outcome of ongoing tariff negotiations remains to be seen, we believe investors should stay alert for emerging opportunities in order to make prudent investment decisions. Diversification continues to be a key strategy for navigating this year's market volatility.

At present, valuation of European equities appears relatively reasonable among developed markets. Higher defense spending, coupled with an accommodative monetary policy stance, is expected to bolster industrial activities, and subsequently, broader economic growth. Investors may consider including European equities within their portfolios as a diversifier.

European equities present growth prospects

In recent years, investors have shied away from European equities due to the region's lacklustre economic performance and excessive bureaucracy. However, that sentiment may shift. The US' decision to scale back its security guarantee to Ukraine has brought European nations together, prompting a collective commitment to increase their defence expenditure. Notably, Germany has set up an infrastructure fund and amended its constitution to exempt military and defence spending from its fiscal budget limit. While these initiatives will likely spur industrial activities and economic growth, their full impact will take time to materialize.

Following the outbreak of the Russia-Ukraine war, Ukraine halted the transit of Russian pipeline gas to Europe, prompting the region to turn to pricier liquefied natural gas as an alternative. Earlier reports floated the possibility that the resumption of Russian pipeline gas could be a potential condition in a future ceasefire agreement. Should that happen, European firms could benefit from lower energy costs, enhancing their competitiveness. However, the negotiation process will likely take time.

Favourable policies support outlook for European banks, insurance and defence industrials

Consumer prices in the Eurozone retreats steadily. In March, the region's CPI fell to 2.2%, creating favourable conditions for further rate cuts. As of March, the European central bank had lowered rates 6 times over nine months. Market participants expect a continued accommodative monetary policy stance could support the stock market to a certain extent. In the first quarter, the MSCI European Index rose about 10.6%, but the valuation remained reasonable. As of end March, the index's five-year average P/E ratio stood at around 15.3x, below the MSCI World Index's 19.6x and the S&P 500's 21.8x.

The European Central Bank's series of rate cuts has helped propelled loan growth across the banking sector. In December, corporate lending in Europe grew 1.5%, the fastest pace in a year and half, and an acceleration from November's 1% increase. In addition, key European banks recently delivered solid corporate earnings, with 20 banks announcing share buybacks totaling EUR 1.8 billion, lending support to share prices.

Turning to insurance stocks, profitability remains well-supported by strong capital positions, ample liquidity, and a stable operating environment. Moreover, Europe's push for greater defence independence has buoyed significant gains in defence-related stocks, including manufacturers for military equipment, engines and armored vehicles across the UK, France and Germany. One prominent German defence company, for instance, has seen its stock price more than double since the beginning of the year. The overhaul of security infrastructure and reinforcement of defense capabilities are long-term commitments, which will provide a foundation for sustained growth among select leading players.

Diversification is the focus of investment strategy this year. We are adopting a wait-and-see approach on whether the US and Europe can reach an agreement on tariffs. Ongoing shifting policies in the US and lingering uncertainty around the Russia-Ukraine war are expected to continue swaying market sentiment. Against this backdrop, investors should consider positioning across an array of markets. As Europe's macroeconomic conditions show a glimmer of recovery, the region may offer diversification opportunities for multi-asset or global equity portfolios.