Insights
Don’t Forget Europe during the US Election
The European equity markets have lagged far behind the US market this year in terms of total return performance. The S&P 500 index is 6.2% ahead of where it started 2020, whereas MSCI Europe is still 6.2% (in euros) or 4.5% (in equivalent US dollars) behind its starting level. It has also been overshadowed on the stock market commentary front.
There are two explanations for these discrepancies: the dominance of FAANG stocks in the S&P 500 and the forthcoming US presidential election. Overall, from a US equity perspective, the most likely scenario of a Biden win could be less positive for stock prices, with a focus on possible corporate tax rises and regulatory changes. However, from a European perspective, such a result could boost the economic outlook with a brighter trade picture.
Interestingly, we have seen large dispersion in performance between the same sectors in Europe and the US (see chart below). As a provider of UCITS ETFs tracking sectors in both regions, we take a keen interest in these differences, seeking to identify the best opportunities in each case. Generally, returns have been higher in the US sectors versus their European counterparts – as expected given the relative moves of their equity markets.
US vs. Europe Sectors - Total Net Returns YTD
Source: Bloomberg Finance L.P., as of 16 September 2020. Past performance is not a guarantee of future results.
This performance dispersion across regions illustrates the impact of sector composition and the distortion caused by the FAANGs. For example, Consumer Discretionary in the US has a significant exposure to Amazon, which has gained 68% YTD, whereas the European sector is heavily exposed to luxury goods and auto manufacturers.* Communication Services is another example of the FAANG phenomenon, with the US sector dominated by Alphabet and Facebook, and the European sector much more exposed to telecom providers.* For the rest of this year, the lack of FAANGS could provide a relative benefit.
The relative performance is reversed in Utilities, one of SPDR Sector Picks for Q3, where the European sector has led because of its faster progress in energy transition.
Europe back in view
Europe has inspired more confidence in investors for a few reasons, one being the EUR 750 million stimulus plan announced by the EU in July – a signal of the bloc’s willingness to “do whatever it takes” to spur economic recovery. Proposals include elements from the EU Green Deal, such as acceleration of electric vehicle charging points, a boost to hydrogen energy, investments in building insulation and refurbishment to meet higher environmental standards, as well as a European data cloud. This unity stands in contrast with the US, where it is increasingly likely that a further fiscal stimulus package will not be delivered this side of the election.
While not wanting to stray into the realm of relative COVID-19 handling, it is interesting to note the vocal support against any further widespread lockdowns as a way of containing the virus – this should limit any further significant step down in growth rates.
Given our relative optimism for Europe’s prospects, we now highlight three ways for investors to access European equity exposure.
Look at sectors
Sector ETF flows have been positive for most of this year, showing that investors are using these vehicles to interpret the vagaries of the equity market, taking advantage of tactical opportunities as some parts of the economy recover quicker than others. While Technology and Health Care funds dominated flows initially, we have seen flows spread more broadly in the last quarter and more cyclically driven.
High levels of performance dispersion between sectors has driven the popularity of this investing approach. At the most extreme, consider the difference in net total returns for the best-performing European sector, Technology, up 7.7% year to date, against those of Energy, down 42.7%; this is a difference of more than 50% (as of 16 September 2020). This level of dispersion is rarely available with other beta instruments, such as regions or factors.
Our SPDR Sector Picks for Europe in Q3 (see our Sector Compass ) were Materials, Health Care and Utilities. Materials has been a top performer in terms of flows and performance. All industry groups (including mining, construction materials, and paper & containers) have returned a positive contribution quarter to date, with chemicals the largest contribution (a reflection of weight and returns). This is fully justified given the continued recovery in PMI Manufacturing figures, healthier end industrial markets and base metals prices (including aluminium, copper, zinc and iron ore) all reaching new highs for year.
Materials could run further as an in-demand cyclical sector, but other sectors may offer greater opportunity from here, such as the more defensive ones.
Utilities fits the bill with the lowest volatility and correlation to equity markets across all sectors. The sector’s high proportion of domestic sales and regulated activity could provide some support, as could the relatively reliable yield of 4.5%. Any return to Value strategies would also see this sector in favour.
The sector has exposure to secular growth stories such as renewables, decarbonisation, carbon storage and reduction. Electricity providers are well placed to drive energy transition in Europe and rising power volumes through increasing electrification.
Health Care performance has lagged in the more cyclically driven markets through July and August this year. Nevertheless, our reasons for making this a Sector Pick continue to resonate, most importantly in the strong earnings resilience that results from non-discretionary expenditure and a broad customer base.
Shifts in provision during the COVID-19 crisis should boost already positive long-term trends, such as increased demand for advanced medicine, better health care processes and remote access. In the short term, demand for vital COVID-19 treatments has resulted in significant vaccine development activity, as well as the search for cures and testing capabilities. These developments should support cash flow and long-term R&D investment, but they have in fact produced a bull market that, perversely, has marked down this sector for its defensiveness.
Look more broadly and engage in ESG investment
We started this year by saying an ESG strategy could be a worthwhile way of getting European exposure. Before the COVID-19 crisis, there was growing excitement about new EU legislation, taxonomy and reporting plans. While there has been some slowdown in activity, the recent pronouncements by Ursula von der Leyen show that ESG remains a key issue. We have seen flows into ESG ETFs have continued to accelerate amid positive performance stories.
Gaining ESG-focused European equity exposure can be straightforward. One solution is to invest in an exclusion index designed to mimic the risk-return profile of the parent index (for example STOXX Europe 600) while cutting out specific activities such as cigarette manufacture, coal power generation and controversial weapons supply.
The STOXX Europe 600 index offers a broad spectrum of exposure to EU and non-EU countries. While the UK stands out as a high risk market currently, given the difficult stage of the Brexit negotiations, heavily discounted valuations may reflect that risk.
How to play these themes:
SPDR offers a range of ETFs that allow investors to access exposure to Europe. To learn more about these ETFs, and to view full performance histories, please follow the links below:
SPDR MSCI Europe Materials UCITS ETF
SPDR MSCI Europe Utilities UCITS ETF
Flows
European-Domiciled ETP Segment Flows (Top/Bottom 5, $mn)
European-Domiciled ETP Asset Category Flows ($mn)
Sources: Bloomberg Finance L.P., for the period 9-17 September 2020. Flows are as of date indicated and should not be relied upon as current thereafter.
* This information should not be considered a recommendation to invest in a particular sector, or security therein, shown above.