Time to invest in Europe’s unknown companies

The consensus trade this year seems to be to overweight the US (again) and underweight everywhere else. The UK is being punished as the Labour government has remarkably managed to make things even worse, while Europe remains out of the limelight because, well, it’s Europe.

This, at least, is the view we have gathered from speaking to investors of all kinds over the last couple of months.

With apologies for sounding snide, but it should come as little shock that the consensus is so far wrong. For European stocks have outpaced the US so far this year and, indeed, since Donald Trump moved back into the White House. It has been the best start to a year for European equities since the late 1980s and the strongest performance relative to the US in almost a decade, according to Bank of America. To put numbers on it, since the start of the year to 21 February the NASDAQ was flat; the S&P 500 up a paltry 1%; and European SmallCap 5%. The Magnificent 7, meanwhile, are down 3%, a significant underperformance of 12.5% relative to the wider European Index (returns in Euros).

This is somewhat surprising. The headlines about Europe’s economy are always bad and this year has been no exception: “Job Loss Fears May Explain Disappointing Euro Zone Consumption”… “Eurozone Growth Threatened by Global Trade War, Economists Warn”… “Security Demands Cast New Shadow on Europe’s Finances”… “Germany’s Economy Stalls Again, Reinforcing Its Reputation as the ‘Sick Man of Europe”…

Even ChatGPT has had a go, as it mockingly informed me: “if the European economy were any slower, it would be studied by archaeologists rather than economists”. (Its other cracker: “the European economy moves so slowly that by the time growth arrives, it has to apply for a visa”).

What then has been driving this largely unexpected performance? From a macro perspective, Trump’s decision not to impose tariffs on the EU has helped. Talk of peace in Ukraine has also benefited continental stocks. Even the fraught German election is being viewed as cyclically positive, given Friedrich Merz’s Christian Democrats need just one coalition partner to secure a working parliamentary majority.

To some extent, ‘twas ever thus in this continental melting pot of countries and cultures. A key ingredient to this stew, though, is that Europe is home to some world class companies – and I bet you have never heard of half of them.

Take Plejd. It is a Swedish smart lighting and home automation company and has shot the lights out (sorry!) with exceptional sales growth and market expansion, significantly exceeding expectations. Esker is a specialist in cloud-based automation for finance and procurement, and is benefiting from rising demand for digital transformation; it was recently bid for, highlighting the M&A opportunity in Europe’s SmallCap space.

Belimo has been on a tear as it makes components for data centres, driving impressive growth. Meanwhile, MTU Aero Engines continues to gain altitude (sorry again!), supported by strong demand for aircraft engines and maintenance services amid the ongoing recovery in global air travel. Sartorius Stedim, a company you probably have heard of, is again looking like the leader it is in the biopharma manufacturing equipment space, rebounding strongly as destocking trends finally ease, driving a surge in new orders and renewed growth momentum.

So yes, macro is always helpful (see the UK again). But European equities are also performing well because some of the continent’s brilliant companies are continuing to outperform consensus expectations. With valuations attractive relative to the US, this dynamic may well continue. It is exactly these sorts of opportunities that we try to identify and own in our European strategies, be that with an income tilt in the European Income Fund; via the European Smaller Companies Fund, which has the added bonus of being able to invest in our very best UK ideas, such as Games Workshop; or our European Smaller Companies Trust (‘MESCT’), which utilises its close-end structure to invest in even smaller companies. With markets looking stretched in areas of the US and tech stocks experiencing a tumble in January, investors have been reminded of the importance of diversification. Now might be as good a time as any to look towards Europe’s unknown companies.