FPXE - European Growth Stocks Are Great Value

2023-12-21 03:00:00 ET

Summary

• Financial markets disrupted by government policies and other factors, making it difficult to predict money flows.
• European small-cap growth companies have been neglected but now offer great value for investors.
• Sentiment is turning as fundamentals of European growth companies are being noticed again, making it a good time to invest.

For years, financial markets have been disrupted due to government policies and other factors.

Multiple quantitative easing policies, negative real interest rates, a pandemic and lockdowns, free distribution of money, green mandates, ESG mandates, huge infrastructure spending financed by unsustainable deficits, tariffs and trade wars, index ETFs and computer algorithms - all these factors have all contributed to make markets look like a game of “guess where the money will flow next” rather than a price discovery mechanism.

Against a background of complex factors such as these, further roiled by war and heightened geopolitical tensions, money flows have changed direction as suddenly as a school of fish. In such a volatile environment, equity investors have understandably sought to minimize risk by buying US- and dollar-based assets, mostly index ETFs and a few select blue chips, notably the so-called magnificent seven.

A risk-off attitude, combined with FOMO (Fear Of Missing Out) on outsized gains from a few stocks lead to a binary market, with small caps on the wrong side of that trade. European small cap growth companies especially stand out as some of the most neglected assets of the last two years. Today, many offer exceptionally great value.

Normalization of Markets

Radical policies have unintended consequences. A favorite saying in the years of abundant cheap money was that a rising tide lifts all boats. Indeed, the wealth effect was achieved by lifting the value of all assets. Tides turn. When the tide receded, all boats came down. But boats are not built to rise and fall passively with the tide. They are built to sail the oceans.

Similarly, stocks may fluctuate up and down, but what matters in the long run is companies’ fundamentals. Low valuations and strong quarterly earnings will eventually attract investors’ attention. Money flows, market rotation and macro trends have overshadowed such an obvious fact over the last couple of years. Whole asset classes were left behind. European small- and medium-cap stocks definitely fall in this group. Many trade at historically low multiples.

Managers of smaller, publicly-traded European companies regularly complain to us about their stock prices. They don’t understand how it is that even when they deliver good performance and meet their targets, their stock prices can be down by as much as 50 or 60 percent. From their perspective, nothing has changed. They continue to deliver on their strategies. And it is true that if anything, more challenging times help successful companies. In tough times, the stronger get stronger.

The combination of rising earnings and lower stock prices—a clear anomaly—is already luring corporate raiders. The CEO of Musti Group, the leading Scandinavian pets service company, recently joined forces with a rich Portuguese investor to take his company private, for example. Earlier in the year, Goldman Sachs Asset Management acquired the Norwegian online game-based learning platform Kahoot. This is just the beginning. More M&A activity can be expected.

Sentiment May Have Turned In November

The shock of the normalization of monetary policies is now behind us. Dollar strength looks to have peaked. Rates of inflation are coming down. Interest rates seem to have peaked as well. For once, Europe may actually take the lead in cutting interest rates next year.

On top of this, fundamentals of European growth companies are being noticed again. Sentiment is turning. Another good quarterly earnings season in Q3, 2023 at last triggered a solid bounce in many European growth stocks in November.

The perfect storm that hit European small-cap stocks is over. This is a good time to invest in European growth stocks. They offer great value.

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