Europe’s rebound: more than just a matter of weather?

There is never a “right time” to read a masterpiece. 
As Jean-Pierre Cometti notes in his preface to Robert Musil’s The Man Without Qualities, a book’s ability to “rise above time […] is that which is usually attributed to masterpieces”: such a work can be read at any age, and especially at any time.
 
Nevertheless, this is a particularly good time to start reading this unfinished novel, which is relatively unknown to French readers, and which is one of the longest and most brilliant of the 20th century.
Written a few years before the great crash of the Second World War, the story places its main character a little earlier, at the beginning of the century, in the antechamber of the 14-18 war. 
 
At a time when Germany and the United States are announcing that they are sending their heavy Leopard and Abrams tanks to the Ukraine, when in Brasilia as in Washington, the alternative parties of the extreme right are encouraging their most exalted members to march on the sacred legislative institutions, when Giorgia Meloni dares to say that Mussolini (who preceded Hitler or Stalin in totalitarianism, despite Hannah Arendt’s misgivings), nevertheless “accomplished a great deal” for his country… everything refers us to the philosophical trepidations of Ulrich, the protagonist. 
 
Like him, as we move along this new century, we are tossed about, sometimes by the backwash of utopian tides, sometimes by that of dystopian currents.  
 
When our scrupulous, worried, climate-conscious gaze turns to 2050, that evanescent Alexandrian lighthouse of net zero, it comes up against a wall as symbolic as that of Berlin. 
This wall is the war in Ukraine, total: forced conscription on both sides of the borders, trenches, pitched battles with armoured vehicles where flesh and steel are mixed, absurd propaganda… and far from the front, the coal-fired power stations are restarted, to the point that we have never emitted as much greenhouse gas in history as we did in 2022: 58 gigatonnes…
No, we are not out of the 20th century yet! On the contrary, we seem to be condemned to return to it. To let ourselves be sucked in, like the protagonist, by “the extraordinary picture of a world that was about to be precipitated into catastrophe”, as Elias Canetti, a close friend of the author, notes.
 
Nevertheless, in the short term, it no longer seems impossible for Europe to escape the catastrophic fate (80% probability of a recession this year) that the markets had in mind. Gas tanks are 85% full, well above the average for the last five years, while the continent usually burns 40% of its consumption between December and February! 
 
Next month, temperatures are expected to be well above their historical average… So much so that according to Morgan Stanley, we should emerge from the winter with 51% full reserves. Adding to this a 16% drop in demand, the bank reduces its price target for LNG in 2023 by 50%! 
 
For the building materials sector (8% of business disappears in energy costs) and the entire European economy, this is a breath of fresh air. 

So much so that investors are rewarding upward revisions to eurozone growth induced by the mild weather with hard cash.
 
After $83 billion of outflows last year (45 consecutive weeks of outflows) we are seeing Europe back in allocations. According to Bank of America, last week was the most prolific week since the war, with $3.4bn invested in European equities. 
 
With market sentiment more positive, equities up 12% since the beginning of the year, valuation back above its historical average (12.9x next twelve months earnings for the Eurostoxx 50[1]), several questions arise for investors. 
 
Are earnings expectations for 2023 (around +0.8% according to the IBES consensus), which have been sharply revised downwards for several months, too timid in relation to an economic scenario that could be better than expected? Or should we remain cautious, relying on the direction of the PMI[2] indicators (down sharply) which show a stronger correlation with profits than GDP growth? Already coming from a historically high level, can companies maintain their record margins in this context? 
 
The Q4 results, ex-post, will offer only a limited view of the future. So far, the semiconductor sector (nearly 25% of sales in China) and financials have done particularly well. 
 
Nevertheless, for the 12% of companies in the Stoxx Europe 600 that have published their fourth quarter results, earnings per share are generally weaker than expected: on average, they are 8% below analysts’ expectations. 
 
However, the positive stock market reaction of some cyclical stocks, whose results remain under pressure, suggests that investors are coming out of their risk-taking hibernation phase.
With energy costs falling, they are less wary of returning to European industrial companies, which can benefit from the historically low euro for exports. 
 
The discount to US equities (29%), which are only half as sensitive to China (4% of sales compared to 8% in Europe), is an additional support for European equities. Moreover, with only one week of positive net inflows since the war, the reallocation potential remains intact. 
 
In other words, European equities do not owe their salvation to the mild weather alone. Above-normal temperatures cannot justify the strongest outperformance of European indices against US equities since 2008. From there to predicting that the European markets are entering a structural phase of outperformance, there is a whole world of caution and humility… As Musil (who opens his novel with one of the most famous meteorological descriptions in modern literature) says: “Act as well as you can and as badly as you should, while remaining aware of the margins of error in your action!

Thomas Planell, Portfolio manager – analyst at DNCA. This article was finalised in January 27th, 2023.

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Termes et définitions
1. Eurostoxx 50 ( Eurostoxx 50 ) L’Euro Stoxx 50 est un indice boursier qui mesure la performance des 50 plus grandes sociétés cotées à…
2. PMI ( PMI ) L'indice PMI (Purchasing Managers' Index) est un indicateur mensuel qui mesure la performance des secteurs de l'industrie manufacturière et des services.
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