European stock market and funds review – is now a good time to invest?

Like most economies around the world, Europe has been plagued with challenges. Stubbornly high inflation, rapidly increasing interest rates, supply chain issues and surging energy prices have hit the continent hard. It’s also had to deal with the devastation caused by the war in Ukraine.

Given these pressures, many expected a deep and lasting recession to follow. This hasn’t quite been the case though. The European economy showed remarkable resilience towards the end of last year, a trend which continued into 2023.

The economy avoided a recession over the winter and saw economic activity and growth pick up pace as the new year began. This had been good news for those investing in Europe.

Unfortunately, it was short-lived. Downgrades to growth were announced in early June, citing the fact that the Eurozone economy (the countries that use the Euro) shrank slightly over the previous two quarters. This means that despite beating performance expectations, the economy has entered a recession.

While this has certainly taken some gloss off Europe’s bounce back, as well as erode some investor confidence, many companies and sectors continue to show resilience. Our analysis suggests that European markets currently look attractively priced and this could present some exciting opportunities for investors.

This article isn’t personal advice. If you're not sure if an investment is right for you, ask for financial advice. All investments fall as well as rise in value, so you could get back less than you invest. Past performance isn’t a guide to the future.

Inflation and interest rates – where are we now?

Europe's economic recovery has its obstacles, with inflation being one of the most significant hurdles.

But while the rate in the Eurozone is still uncomfortably high, it did dip to 6.1% in May this year, down from 7% in April. In fact, inflation in the European Union as whole, dropped to 7.1% in May 2023, down from a peak of 11.5% in October 2022.

While inflation seems to have peaked across most of Europe, and is beginning to fall, the European Central Bank (ECB) aren’t quite comfortable yet. Christine Lagarde, the President of the ECB, remains unwavering in her goal of bringing inflation down to 2%.

To do this, the ECB has raised interest rates at their fastest pace ever. The most recent was 0.25%, bringing rates to 3.50%, a level not seen since 2001.

To put the speed of these hikes into context, rates were -0.5% in July 2022. Lagarde has defended this, explaining that the moves were aimed at fighting inflation, which remains a top priority.

Raising rates too quickly might push more countries across Europe into recession. Increasing too slowly, and inflation spirals out of control. While Lagarde has said further hikes are in the pipeline, the pace will be slower.

Some believe the decision to slow the pace of hikes is because the Eurozone has fallen into recession. It could also be due to the European banks’ possible vulnerability and tightening lending conditions following the US regional banking issues.

What's next for US regional banks after the Fed pauses interest rate hikes?

As ever, there’s still plenty of uncertainty. We could see an end to the war in Ukraine, which could boost sentiment and reduce inflationary pressures. In turn, rate hikes could be paused.

On the other hand, the conflict could escalate, geo-political tensions could rise and the looming debt crisis in countries like Italy, might add more strain on the ECB’s monetary support.

How have European stock markets reacted?

Despite the Eurozone slipping into recession, with an anaemic growth of -0.1% in both the fourth quarter of 2022 and the first quarter of 2023, there’s a lot of good things to talk about.

Over the last 12 months, markets have been strong, with European shares outperforming US shares.

One of the drivers behind this has been interest rates. When rates were low, investors flocked to the ‘growthier’ tech giants in the US, but as rates and the cost of borrowing has climbed, these companies have struggled.

Value companies, ones thought to be trading at a discount or undergoing a turnaround, regained favour. Because Europe is considered more of a value-orientated market than the US, investors have taken advantage.

Value investing – 3 share ideas ready to bounce back?

Another reason for Europe’s outperformance has been the strength of its financial sector. Europe avoided much of the fallout from the US banking crisis, owing mainly to its superior regulatory policies and capital reserve positions. As a result, banks like UniCredit in Italy, and Banco Santander, a market leader in Spain, have rallied.

The re-opening of China has also helped European companies. China accounts for roughly 8% of European sales, with many sectors, particularly semiconductors and luxury goods, seeing increases in both demand and revenue.

It’s not all good news though. Germany, Europe’s biggest economy, entered a recession in the first quarter of this year. As price pressures mounted, a fall in household and government spending followed, which has been a real burden on the economy.

While this has also hindered Europe’s growth, many expect Germany to pick back up in light of falling inflation and lower energy costs. The German stock market has already started to rebound and reached an all-time high in May this year.

Why Germany's economy is struggling

Performance of European markets vs the US

Scroll across to see the full chart.

Past performance isn’t a guide to future returns. *Lipper IM, to 31/05/2023.

How have European Wealth Shortlist funds performed so far this year?

As a result of European markets bouncing back so far this year, most of our Wealth Shortlist European picks have performed well. While performance has varied between funds, each have outperformed their peer group over the last 12 months.

This is a very short timeframe when looking at performance though and past performance isn’t a guide to the future.

Investing in these funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

For more details on each fund and its risks, use the links to its factsheet and key investor information below.

The best performing Wealth Shortlist European fund over the last year was CT European Select.

The fund returned 15.67% over this period, outperforming the average return of peers in the IA Europe excluding UK sector by 8.90%*. Benjamin Moore is the lead manager on the fund and favours a style of investing known as growth.

One thing we like about Moore is his discipline to stick to process. Even though his ‘growth’ style of investing fell out of favour at times last year, he continued to invest in his favoured companies, at prices he considered more attractive.

Growth stocks have rallied so far this year, outperforming value stocks, which boosted the fund’s performance. Sectors like technology, consumer discretionary and healthcare, also performed well.

Find out more on CT European Select, including charges

CT European Select Key Investor Information

Polar Capital European ex UK Income and BlackRock Continental European Income also performed strongly, delivering returns of 10.15% and 8.11%, respectively. Both funds outperformed the average return of peers in the IA Europe excluding UK sector.

Nick Davis, lead manager on the Polar Capital European ex UK Income fund, favours an investment style known as value. He invests in companies that he believes are trading at a discount or undergoing a turnaround. This style is different to a lot of other European managers. So, we think it could provide some diversification to European growth funds as well as other global funds focused on growth. It could also work alongside an investment portfolio focused on income.

Andreas Zoellinger, the lead manager on the BlackRock Continental European Income fund, can invest in ‘growth’ and ‘value’ stocks, but the approach is quality orientated. He ensures a focus on balancing quality dividend-paying companies which have the potential for dividend growth over time, with companies that pay a higher income now, but perhaps have less potential for growth.

Find out more on Polar Capital European ex UK Income, including charges

Polar Capital European ex UK Income Key Investor Information

Find out more on BlackRock Continental European Income, including charges

BlackRock Continental European Income Key Investor Information

Barings Europe Select Trust was the worst performing fund in the European sector of the Wealth Shortlist.

The fund fell 1.95%, but held up better than peers. Over the last 12 months, the fund has outperformed the average return of the IA European Smaller Companies sector by 2.07%.

Nick Williams is the lead manager on the fund and invests in smaller European companies, which is a part of the market that has been under a lot of pressure recently.

Find out more on Barings Europe Select, including charges

Barings Europe Select Key Investor Information

Past performance isn’t a guide to the future. Source: *Lipper IM, to 31/05/2023.

Fund Insight: our weekly email

Sign up to receive our expert fund research and insights.