Markets Brief: European Stocks Shine Despite War in Ukraine

Resilient economies are helping European stocks outperform U.S. and Canadian markets.

Sandy Ward 24 February, 2023 | 4:48AM
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One year after Russia invaded Ukraine, world markets are showing their resilience, and for some investors, European stocks, which shuddered last year, are looking particularly attractive.

Despite the havoc wreaked initially by Russia’s act of aggression, notably disruptions to supplies of energy and agricultural staples, major European economies as well as the United States have so far managed to skirt severe recessions even as high rates of inflation have persisted here and abroad.

“The war still matters a great deal because it creates a risk of a lot of things that can go wrong,” says Andy Kapyrin, co-chief investment officer of private wealth firm, CI RegentAtlantic, noting the potential for trade disruptions and commodity price pressures and higher inflation. “But the war’s moment of highest economic salience was last spring, and I expect it will impact markets and economies less and less as time goes on.”

Europe’s Economic Resilience
The eurozone market, in particular, has been buoyed by the success of navigating through numerous crises created by the conflict, including reducing its reliance on Russian natural gas and investing in its own energy infrastructure, says Peter Berezin, chief global strategist at BCA Research, a Montreal-based independent provider of global investment research. That’s created a “sense of optimism,” as has improved economic data, strengthening manufacturing and services numbers, and positive consumer sentiment. “It’s good news for Europe and global markets,” says Berezin.

The Morningstar Europe Index is up 9.4% for the year to date, the Morningstar Germany Index has risen 12.9%, and the Morningstar France Index is nearing record highs, gaining 12.4% so far this year. These rallies compare with an advance of 8.25% in the Morningstar US Market Index and 6.46% in the Morningstar Canada Index.

Like Kapyrin, BCA’s Berezin expects the Russia-Ukraine “conflict will persist” and that could create “various tail risks” for countries already coping with high inflation.

One potential threat: higher oil prices, especially if Russian President Vladimir Putin makes good on his threat of cutting oil production and Saudi Arabia doesn’t produce more to offset the supply reduction. But “the bigger risk to the bullish view on Europe is if the conflict spills outside its current domain,” says Berezin, and the U.S. and its NATO allies get dragged into the fray.

Geopolitical Events Can Be Buying Opportunities
The strength in global markets demonstrates what many investment strategists noted a year ago when the war started: Geopolitical events might trigger emotional responses that jolt markets temporarily, but they don’t ultimately change the economic fundamentals on which investment decisions are made, instead, create buying opportunities.

“Knee-jerk reactions can be fraught with error,” says James St. Aubin, chief investment strategist at Sierra Investment Management. “The reaction can be an overreaction, and the results can be counterintuitive” as has proved true in Europe, where investors were initially spooked by the prospect of a calamitous energy shortage that never materialized, helped by a mild winter.

Berezin of BCA, however, considers geopolitical events to be more nuanced. While there are geopolitical shocks that have temporary impacts, there are those that represent structural shifts among global powers that can lead to profound changes in the global financial system. He points to tensions between the U.S. and China and the possible end of globalization as geopolitical forces that could result in long-lasting effects on the global financial system.

When we spoke with CI RegentAtlantic’s Kapyrin following the invasion last year, he predicted the Fed would embark on the fastest pace of rate hikes since 2002-03 despite the war and that technology stocks would continue to underperform as a result. He also noted U.S. stocks would be held back because of the heavy exposure to technology in the major indexes and recommended a weighting of at least 25% in international stocks, highlighting Europe as “the better opportunity.” All good calls. He still favors international diversification.

European Stocks Look Attractive
“It’s an attractive time to own European equities,” says Kapyrin, even if the region’s economies grow “relatively slowly.”

European and international stock markets have greater exposure to sectors that are expected to do well in a higher inflationary and higher rate environment, including major consumer brands, energy suppliers, and industrials, he says. They should also benefit from the reopening of China’s economy, he says. Fund investors appear to see Europe as attractive as well.

In January, Europe-focused equity exchange-traded funds attracted $5.1 billion in flows, the most since May 2021 and second only to emerging-markets exchange-traded funds, which pulled in $5.4 billion, according to Morningstar Direct. That’s a sharp reversal from a year in which investors steadily sold off European equities. For the trailing 12 months, outflows from European equity ETFs totaled $6.4 billion through January.

The JPMorgan BetaBuilders Europe ETF (BBEU), based on the Morningstar Developed Europe Target Market Exposure Index, took the top spot of all ETF strategies, attracting $3.6 billion in net assets for the month of January and returning 9.56% for the year to date. In contrast, U.S. exchange-traded funds recorded outflows of $1.4 billion for the month.

 

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
JPMorgan BetaBuilders Europe ETF59.80 USD-1.42Rating

About Author

Sandy Ward  is a markets columnist for Morningstar.

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