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Europe tends to be a blind spot for Canadian investors, perhaps because the continent lacks a compelling story for money managers. But that may be changing as some strategists think European equities could outperform this year.

“We have a positive outlook for European equities in 2024,” says Philip Petursson, chief investment strategist at IG Private Wealth Management in Toronto. “Valuation combined with the potential for higher earnings growth leads us to view the equity markets in that region favourably.”

He says Europe’s broader economy has suffered from the same challenges Canada and the U.S. faced – higher but slowing inflation and higher central bank rates. However, the European economy faced the additional challenge of stronger trade and economic ties with China. The Chinese economy continued to remain in borderline recessionary conditions in 2023, which affected Europe.

“We see the potential for China to turn its growth around in 2024 with additional stimulus, which will also benefit Europe,” he says.

From a valuation perspective, Mr. Petursson notes that the EuroStoxx 600 is the cheapest in 20 years relative to the S&P 500.

“Europe is attractive on its own from a valuation perspective but compared with other global indexes, it’s extremely attractive,” he says. “However, valuation is a poor predictor of market returns over the short term. We will be patient with Europe as valuation comes back in line with historical trends.”

As for the best way for Canadians to invest in Europe, Mr. Petursson’s firm prefers to gain exposure through an international equity fund or exchange-traded fund. He notes Europe will be the largest weight in an international portfolio and will be balanced out by exposure to the U.K. and Japan.

Potential challenges lurking

While there’s significant positive sentiment toward European equities, some market observers still see challenges ahead.

“There are several reasons to fundamentally doubt the prospects for a major uplift in the outlook for European stocks over the coming year,” says Bill Blain, market strategist at Bowline Capital Partners in London.

He points to a sense of “economic malaise” in Germany, France and Italy, exacerbated by political turmoil in several countries.

Despite that, Mr. Blain says Europe may surprise by being “less bad” than expected.

“Things are never as bad as you fear, and seldom as good as you hope,” he says. Mr. Blain adds some sectors, such as airlines and tourism, are doing “exceptionally well,” and banks look stronger than many expected.

One factor driving interest in European stocks is the conviction the European Central Bank (ECB) has stopped its interest rate tightening cycle and will cut rates in the first half of this year – before the U.S. Federal Reserve Board. But Mr. Blain feels the prospects for European rate cuts look more limited than the market expects.

Despite these concerns, Mr. Blain says there are reasons under the surface to be positive about Europe.

“Although the population is aging and demographics are a concern, the possibilities of AI-driven productivity gains for rich European nations should not be underestimated,” he says.

Mr. Blain also notes the potential economic gains from renewables and rearmament are significant. “Europe and the U.K. are places to look for hidden value.”

The recession question

Europe’s economic outlook is a key consideration when strategists make their assessments of the region’s markets.

“We expect a recession to emerge toward the middle of 2024, which will drag down European earnings,” says Mathieu Savary, chief European strategist at BCA Research Inc. in Montreal.

He is calling for European stocks to fall by 20 to 25 per cent in the first half of 2024. He expects the recession to be shallow, with earnings recovering rapidly in 2025. As a result, he sees European stocks rebounding firmly in the latter part of this year.

Mr. Savary says affordability is the main tailwind for European equities as they’re trading well below their average price-to-earnings ratio of the past 10 years. Moreover, they’re well placed to take advantage of a capital expenditure-led rebound in growth in 2025. Their main handicap in the near term is their elevated cyclicality, which renders them highly sensitive to a recession.

In addition to hopes for rising values, European stocks have the added benefit of adding diversification for Canadian investors. Mr. Savary notes that European equities offer a good amount of diversification vis-à-vis U.S. shares because they underweight tech and overweight cyclicals such as financials, industrials, materials and consumer discretionary stocks.

Mr. Savary says U.K. stocks have a particularly interesting profile as a diversifier because they offer strong protection against inflation via large overweight positions in materials, energy, consumer staples and health care. As a result, while the FTSE 100 suffers near-term risks from a possible recession, he still believes it will be one of the best-performing markets in late 2024 and early 2025.

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