Old continent in a new light

• 

  Serge Nussbaumer
  Chefredaktor

Elections will be held in Germany on February 23. Almost 60 million eligible voters will be called upon to decide the future composition of the Bundestag. Just under three weeks before the election, everything points to a change of power. The CDU and CSU are clearly in the lead with their top candidate Friedrich Merz. In an election campaign dominated by the economy and migration, there is no shortage of negative superlatives. Calling Germany the “sick man of Europe” is no longer enough for some candidates. The chairman of the Free Voters and Bavarian Minister of Economic Affairs, Hubert Aiwanger, sees his country on the way to becoming the “corpse of Europe”.

The flourishing life

There can be no talk of dying on the German stock exchange; on the contrary, life is flourishing. Over the past twelve months, the DAX has gained more than a quarter in value. This puts it at the top of the ranking of the most important European benchmark indices (see chart 1). Germany is more of a driving force than a drag on the stock markets of the old continent. However, public perception – including among investors – by no means reflects this development. In fact, the fierce debate about the crisis during the Bundestag election campaign seems to be having an impact far beyond the borders of Germany. Quite a few politicians, economists, media and investors see Europe on the brink.

This mood has a lot to do with geopolitical developments in the world. Europe finds itself in a kind of dilemma. Russia and China are pushing into the continent from the East and the Far East. Looking across the Atlantic to the west, a new and familiar face has emerged since January 20. Donald Trump returned to the White House on that day, a man who hardly has a good word to say about Europe, or more specifically the European Union. “They treat us very, very badly,” he said shortly after taking office. Trump justified this accusation with the high US trade deficit with the EU and claimed that the Europeans were not buying cars and agricultural products from the USA. Even before he was sworn in, the Republican had called on the EU to import more oil and gas from the US. “Otherwise there will be endless tariffs!” he threatened.

Macroeconomy: slight improvement

There are good reasons to take an analytical look at the old continent despite the political roar from the White House and the “post-mortem” in the German election campaign. We take a top-down approach and start by looking at the macroeconomic environment. “The eurozone economy will grow moderately in 2024,” says Jörg Krämer, Chief Economist at Commerzbank. There are clear regional differences. In Germany, gross domestic product shrank last year. France recorded growth of 1.1%, in Spain the tourism boom resulted in an increase of 3.2% and Italy’s economy grew by 0.5%.

After a tough economic winter, Krämer expects a moderate upturn in the new year. “The economy in the eurozone should benefit from the ECB’s interest rate cuts,” says the economist. At the end of January, the European Central Bank continued its easing course and lowered the deposit rate by 25 basis points to 2.75%, as expected. It is possible that monetary policy is already having an impact on corporate sentiment. In any case, the HCOB Purchasing Managers’ Index for the eurozone has risen to 50.2 points. This is the first time it has been above the growth threshold of 50 since August last year. “The start to the new year is slightly encouraging”, comments Cyrus de la Rubia, Chief Economist at Hamburg Commercial Bank (HCOB), on the results of the survey of a representative sample of 5,000 companies. “Anything but encouraging”, however, is the development on the price front.

Permanent inflationary pressure

Inflation does indeed remain an ongoing issue. High wage settlements and the economic recovery suggest that consumer prices will continue to rise. “Structural inflation drivers such as demographics, de-carbonization and de-globalization are also working in this direction,” says Commerzbank economist Jörg Krämer. His bank assumes that the inflation rate in the eurozone will be above the ECB’s target level of 2% this year and in 2026. A certain level of inflation does not necessarily have to be bad for the stock markets. What is important here is that companies can pass on the cost pressure and increase their profits. Not everything is bad in Europe in this respect either.

Microeconomics: Strong large caps

Take SAP, for example: from October to December 2024, Europe’s largest software giant increased its surplus by 35% to EUR 1.62 billion. The Germans are correspondingly optimistic about the future. “Thanks to our strong position, we are confident that we will be able to accelerate our sales growth by 2027,” says CEO Christian Klein. One driver is the cloud business. In this segment, SAP is aiming for revenue growth of 26% to 28% at constant exchange rates by 2025. For the operating result of the company as a whole, the CEO is forecasting an increase of between 26% and 30%. And the cash register should be ringing strongly: At around EUR 8 billion, the free cash flow targeted for the current period is almost half the level of 2024.

Unsurprisingly, SAP is focusing on artificial intelligence (AI). Among other things, the AI assistant “Joule” enables customers to work more efficiently and automate processes based on their business data. “More than 20,000 SAP developers are already using Joule for Developers,” said Christian Klein in a conference call. The top manager is not getting caught up in the excitement surrounding the new Chinese AI “DeepSeek”. Fear of the strong and cheaper competition from China had caused many AI shares in the technology segment to plummet. Although the SAP boss was enthusiastic about the performance of “DeepSeek”, he said that Europe had nothing to hide.

The heavyweight in the MSCI Europe Index put in a strong performance two days after the number 3. ASML Holding, a manufacturer of lithography systems for the semiconductor industry, booked orders worth EUR 7.1 billion in the fourth quarter of 2024. On average, analysts had only expected the Dutch company to achieve just under EUR 4 billion. The chip supplier also exceeded expectations in terms of net profit: ASML earned just under EUR 2.7 billion in three months. “The development of AI is the most important growth driver for our industry,” said CEO Christophe Fouguet. ASML’s systems are used by manufacturers of high-performance processors. Despite the recent “DeepSeek” shock, the CEO confirmed the forecast for 2025, aiming to increase sales from EUR 28.3 billion to EUR 30 to 35 billion. At the same time, ASML is aiming for a gross margin of 51% to 53%. In 2024, this figure was 51.3%.

Moderate growth, low valuation

Despite solid balance sheets and optimistic forecasts from the heavyweights, Europe cannot keep pace with other regions in terms of earnings growth. This is particularly true in comparison to the USA. Thanks to the AI boom and business-friendly policies, the profit engine on Wall Street is running at full speed. But momentum is also picking up on this side of the Atlantic. Analysts believe that the companies in the MSCI Europe will achieve double-digit percentage earnings growth in the coming year (see chart 2).

In view of these prospects, European equities are not expensive. On the contrary: based on the earnings expected for 2026, the price/earnings ratio of the MSCI Europe is just over 12. This much-noticed ratio is approaching the 20 mark for the S&P 500 Index. This discount is accompanied by a clear advantage in dividend yields. Currently, the yield on expected distributions for the next 12 months in the MSCI Europe is 3.3%. This means that the aggregate dividend yield of the more than 400 companies in this continental benchmark would exceed that of the S&P 500 Index by a good 2 percentage points (see chart 3).

To the point

Skeptics may now raise their hands and call the valuation discount on European equities justified in view of the structural problems. On the positive side, however, the opportunities on the old continent can hardly be overlooked. In addition to the emerging political shift towards more business-friendly legislation – also and especially in the wake of the German elections – the prospect of further interest rate cuts and the wealth of internationally successful companies speak in favor of an investment. China could prove to be a kind of “joker”. An upturn in the Middle Kingdom, supported by the latest economic stimulus programs, would play into the hands of Europe in particular. The man in the White House remains a key risk. Should Donald Trump get serious with his tariff threats against Europe, he could nip the fragile upturn on this side of the Atlantic in the bud.

Investment solutions

Optimists can buy the MSCI Europe with the Exchange Traded Fund EUREUA into their portfolio. With the ETF launched in 2009, UBS physically tracks the diversified index. This means that the 414 shares included are held in the fund assets. The dividends are passed on to the investors. The total expense ratio of the EUR 300 million ETF is kept low at 0.10% p.a.

The recent “DeepSeek” turbulence has also made the European market interesting for fans of yield enhancement products. The historical volatility of ASML Holding over a period of one month is more than 40%. For the MSCI Europe Index, this figure is in the single-digit range. With the Barrier Reverse Convertible LTACVK investors can bet on the situation at the Dutch stock market heavyweight calming down. Leonteq pays a coupon of 8.60% p.a. for the CHF-denominated product. As long as the underlying does not touch or fall below the barrier, investors receive the full nominal amount on maturity. At EUR 440.635, the relevant threshold is 37.5% below the price of ASML Holding.

Of course, there are also solutions for Eurosceptics on the Swiss market for structured products. Anyone assuming that the old continent will continue to fall behind and the stock market will turn downwards could take a look at the short products on offer. A mini future with the ISIN DE000SV0D701 converts falling prices of the EURO STOXX 50 Index into profits with a leverage of currently 5.6. Société Générale has set the stop threshold at 6,079.82 points, which is around 15% above the level of the eurozone index. This cushion should not obscure the fact that the bears are threatened with significant losses if the positive momentum on the European stock markets continues.