To The Moon

$Vanguard FTSE Europe ETF(VGK)$   

As European stock markets reach record highs, many investors are puzzled by this performance against a backdrop of technical recession. Here's why the STOXX 600's strength might be more sustainable than it appears at first glance.

1. The "Best Recession Ever"?

Europe's current economic situation defies traditional recession patterns. Despite technically being in a recession, unemployment remains remarkably low at 6.3% - down from 7.4% in March 2021. Core inflation has stabilized around 2.7%, suggesting the worst of the inflation crisis is over. This unique combination of stable employment and moderating inflation has created a goldilocks scenario for many companies, particularly in the industrial and financial sectors.

The European Central Bank has been notably proactive, already beginning its rate-cutting cycle with a reduction to 2.75% in deposit rates. This early policy pivot, combined with well-telegraphed future cuts, provides businesses and investors with much-needed clarity on the financial horizon.

 2. Valuation Appeal in a Global Context

European equities present compelling value compared to their global peers. Many high-quality European industrials and financials trade at single-digit P/E ratios, while similar US companies command multiples above 20x. This valuation gap has caught the attention of global investors, particularly those concerned about US market valuations where even traditional defensive stocks like $Procter & Gamble(PG)$  and $McDonald's(MCD)$   trade at technology-company multiples.

European companies also offer attractive dividend yields (averaging around 3.3%) compared to the S&P 500 (approximately 1.5%). These dividends are typically well-covered by earnings and supported by conservative balance sheets, making them particularly attractive to investors seeking alternatives to low-yielding bonds.

3. Strategic Advantages in Key Sectors

European companies are well-positioned in several critical growth areas. Companies like Schneider Electric, ABB, and Infineon are major players in industrial automation, energy transition, and semiconductor manufacturing - sectors crucial for AI implementation and sustainable energy development. These companies often fly under the radar compared to their US counterparts, despite their global leadership positions.

The weak euro has been a significant tailwind, making European exports more competitive globally and boosting overseas earnings when converted back to euros. This currency advantage has been particularly beneficial for Europe's strong industrial and luxury goods sectors.

4. Structural Market Shifts

A notable shift is occurring in global investment flows. Concerns about US fiscal debt, tight spreads in US corporate bonds, and instability in Asian markets have led many institutional investors to reassess their European exposure. The region is increasingly viewed as a "safe-haven" with growth potential, particularly given:

- Strong corporate balance sheets with lower debt levels than US peers

- Conservative financial management practices

- High-quality industrial base with global reach

- Growing tourism and retirement migration boosting consumer sectors

- Improved energy security following successful diversification post-Russian gas crisis

This combination of factors suggests the current market strength might be more than just a temporary phenomenon, potentially marking a longer-term rerating of European assets.

 Investment Implications

For investors considering European exposure, focus on:

- High-quality industrials and financials trading at reasonable valuations

- Companies with strong balance sheets and sustainable dividend policies

- Businesses benefiting from energy transition and automation trends

- Companies with significant export exposure benefiting from currency advantages

While risks remain, including political fragmentation and demographic challenges, the current confluence of factors suggests European equities may continue to offer attractive opportunities for patient investors seeking value in an increasingly expensive global market environment.