European equities: A resurgent diversifier
In a surprise to many investors, European equities have advanced sharply over the past several months, including significant outperformance relative to U.S. stocks. The improved backdrop for European markets reflects a confluence of factors, including a stronger currency and a manufacturing renaissance, underpinning opportunities for improved diversification at attractive valuations for global investors.
U.S. versus European equities
Net total return, Rebased to 100 at April 30, 2022
Source: MSCI, Principal Asset Management. Data as of April 30, 2023.
For most of the past decade, U.S. stocks have outperformed European stocks on the back of a strong U.S. dollar, solid earnings growth, and a high concentration of mega-cap tech companies. However, over the past several months, European equity markets have outperformed U.S. stocks, reigniting optimism about the diversification benefits of investing abroad.
Dating back to the Global Financial Crisis, foreign investors have broadly shunned European stocks, reflecting lingering pessimism for the region. The onset of the war in Ukraine, and its implications for energy prices and security, hit European stocks especially hard. However, as some of these concerns have abated, the focus on Europe is shifting to structural changes: its innovative approach to energy independence, digitalization, and a manufacturing renaissance driven by the global reshoring of supply chains. Also, the region's financial system has improved significantly after nearly 15 years of deleveraging and consolidation.
Like other international markets, Europe has benefitted from a weaker U.S. dollar, which peaked in October 2022 after its decade-long rise. And despite recent outperformance, European companies continue to trade at historically low valuations compared to U.S. peers, providing a significant runway for further valuation improvement.
As U.S. markets navigate bouts of uncertainty and volatility, European equities may be an attractive diversifier for investors—offering a potential gateway to global growth at a discount.
For a deeper dive into the evolving landscape for equity markets outside the U.S., read The resurgence of international equities.
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