Europe's "Man on the Moon" Moment
The European equity market was one of the worst-performing in 2020 amid the ravages of COVID-19, with many stocks also subject to dividend limitations. However, as we move through 2021, we believe Europe should see the benefits of a V-shaped economic recovery as the dissemination of a vaccine will benefit all economies. While initially it will feel like vaccine distribution is slow, we see it as likely to accelerate with benefits rolling out exponentially. In addition, we finally have a resolution to Brexit, and the removal of uncertainty should benefit certain stocks, including domestic UK stocks, which have low valuations. Many investors are seeing short-term negatives in Europe, and expectations are low. But we see many reasons to be optimistic about the longer term.
A Look at Europe’s Positive Attributes
Europe is home to many countries with diverse cultures and perspectives, and some of the highest gross domestic product (GDP) per capita in the world. The European Union (EU), representing a subset of these countries, has helped bring more cohesion to the region, including a common currency, cross-border travel and immigration, and a common EU budget. Since the Global Financial Crisis over a decade ago, from which no economy or stock market was immune, GDP in both the United States and Europe has doubled. Despite this similar economic performance, the European region’s stock market has underperformed, particularly against the United States.
We believe investors are ignoring many of Europe’s positive attributes; European countries are world leaders in many areas. One of these is green investing, making the planet better for future generations.
While conventional wisdom is that Europe is over-regulated, we think there is another side to this conclusion—Europe is also leading the way in terms of protecting the privacy of its citizens’ data. It is also holding companies accountable for having too much power, fostering competition and enabling smaller companies to enter these markets. Finally, it has been a leader in its handling of COVID-19, using the crisis to bring the region closer together.
While US President-elect Joe Biden has green ambitions, Europe is at the forefront of environmental investing. From the percentage of electricity generated from renewable resources—including wind farms off the coast of Germany, hydroelectric power generated in northern Europe and its commitment to the Paris Climate Accord—Europe is the leader on the world’s green stage. At the end of 2019, the European Commission passed the Green Deal, with the overriding objective of making Europe climate neutral by 2050. Europe’s Green Deal is expansive, designed to level the playing field and ensure that companies operating in Europe are not placed at a competitive disadvantage as they invest for the good of the planet. The plan includes carbon tariffs that will be levied on products imported into Europe from countries that do not have similar carbon containment measures, incentives to transition away from fossil fuels and support for “green capitalism.”
Other initiatives in the new Green Deal are focused on sustainable mobility. Rail transport is one of the most carbon-friendly modes of travel. Improving rail networks and increasing the penetration of rail transportation—both of goods and people—will benefit companies tied to a dedicated rail infrastructure. Companies which provide fastening systems, tie technologies and maintenance services can help rail networks upgrade their tracks where necessary, improve the condition of their existing track and turnouts, and reduce train downtime due to unplanned rail network outages through digitalized condition monitoring.
In our view, the new Green Deal puts Europe at the forefront of the world’s move toward creating a more sustainable planet. European Commission President Ursula von der Leyen described it as Europe’s “man on the moon” moment—and we agree.
Data privacy and protection has been on the minds of many citizens, and Europe has been ahead of other nations in protecting privacy and data. On May 25, 2018, the General Data Protection Regulation (GDPR) came into effect, implementing some of the toughest privacy and security laws in the world. The regulations impose obligations on organizations, regardless of their domicile, if they are targeting or collecting data that relates to people in one of the EU countries. While these regulations represent an additional cost to companies, we believe the benefits of personal information security and data privacy that they support far outweigh those costs, so that society, as a whole, is better off.
The EU has a long history of being tough on technology companies. From early fines against Microsoft to its more recent actions against social media and platform companies, the Commission has taken a tough stance regarding data privacy, hate speech and anti-competitive actions. At the forefront of technology enforcement actions, companies that have dominant positions in Europe are subject to higher levels of scrutiny than in other regions.
While conventional wisdom would say that regulation hampers businesses, we think there is another side to this debate: regulation may foster competition. Looking back at the history of antitrust enforcement, many investors may be surprised to learn that the world’s vibrant software industry was created in response to the potential threat of antitrust action against International Business Machines (IBM). IBM had been bundling its software and hardware and when it split those two businesses, smaller entrepreneurial software companies were given access to this growing industry.
With Europe at the forefront of regulatory enforcement in the technology space, we think it could be creating opportunities in the region for smaller companies to enter and compete in markets where the dominant positions of a few companies prevented them from making inroads. This places Europe at the forefront of creating a level playing field in the technology space.
According to a recent Pew Research Center survey, members of the 27-member EU are predominantly satisfied with how their governments have handled COVID-19, with 71% of the population in favor of their country’s response to the pandemic.1 This contrasts with other regions, namely the United States and the United Kingdom, where citizens have been significantly less satisfied with their government’s pandemic response; more than half of the people polled in those countries said the government’s response was “poor.”2 We think Europe’s more effective handling of the pandemic should lead to a more rapid emergence from it.
The beneficiaries of the faster economic recovery should be cyclical companies; for example, a low-cost chemical producer which could benefit from improving end markets as well as from tightening supply conditions as capital projects were delayed or canceled due to the pandemic.
A More United Future
While the initial response to COVID-19—namely shutting borders and restricting movement—was against the spirit of the Schengen Agreement,3 cohesion within the European region is on the rise. Despite the sometimes-contentious Brexit negotiations, it is likely the United Kingdom will continue to remain close partners with the EU. Within the region, the passing of the European recovery fund, representing a package of grants and loans for regions the pandemic has hit hardest, more closely unifies the region economically. And, the issuance of a common bond integrates the region financially.
The citizens of Europe seem to agree—the Pew Research survey also revealed 44% of respondents say the coronavirus has made the country more unified. In the United States, 77% believe the country is more divided than pre-pandemic.4
As investors, we need to focus on the future while being cognizant of the past. We see Europe acting as a leader on the world’s stage in many areas, from renewables investments to data protection. And while many see Europe as highly regulated, we see the benefits that these regulations can accomplish through fostering healthy competition across the region for many years to come.
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1. Sources: Pew Research Center, World Economic Forum, “People in these countries think their government did a good job of dealing with the pandemic,” September 15, 2020.
3. The Schengen Agreement is a treaty which led to the creation of Europe’s Schengen Area, wherein internal border checks were largely been abolished, allowing for free travel between countries.