2023 could be called the year of the ‘magnificent 7’, referring to the seven US tech giants that dominated investing headlines – Apple, Amazon, Alphabet, Microsoft, Meta, Tesla, and Nvidia.
However, back on this side of the Atlantic, European stocks were making their own waves and even breaking records.
Italy’s FTSE MIB rose 28%* in 2023. Spain’s Ibex 35 rose 22%, and Germany’s Dax index rose to a fresh record high and was 20% higher in 2023.
Overall, the Eurostoxx 50, an index of Europe’s 50 largest companies, rose by a respectable 19%.
Europe’s top performer last year, the Italian FTSE MIB index, hit its highest level since 2008. Its market capitalisation increased by more than 20% in 2023 to €761bn, nearly 40% of Italian GDP.
Dec 18 – Dec 19 | Dec 19 – Dec 20 | Dec 20 – Dec 21 | Dec 21 – Dec 22 | Dec 22 – Dec 23 | |
|---|---|---|---|---|---|
FTSE MIB | 28.28% | -5.42% | 23.00% | -13.31% | 28.03% |
IBEX35 | 13.17% | -15.17% | 6.86% | -5.56% | 22.76% |
German Dax | 25.48% | 3.55% | 15.79% | -12.35% | 20.31% |
Eurostoxx 50 | 25.51% | -4.72% | 20.56% | -11.90% | 19.19% |
Eurostoxx Banking | 11.55% | -23.32% | 35.45% | -4.64% | 23.46% |
EURUSD | -2.04% | 9.62% | -7.93% | -5.39% | 3.12% |
This article isn’t personal advice. If you’re not sure whether an investment’s right for you, ask for financial advice. All investments and any income from them can fall as well as rise in value, so you could get back less than you invest. Investing is best considered for five years or more. Ratios also shouldn’t be looked at on their own to make investment decisions.
What drove European stock markets?
At a sector level, there was outperformance in the financial and consumer cyclical sectors. The Eurostoxx banking index also rose 21% in 2023, so a strong performance for banks was one of the key drivers for European stocks in 2023.
One reason for the banking sector’s outperformance was rising interest rates.
The European Central Bank (ECB) hiked interest rates by 2% in 2023, pushing the benchmark interest rate up to 4.5%. This helped boost banks’ net interest margin, this is the difference between the interest income generated by banks and the amount of interest paid out to their lenders.
Financial markets are pricing in more than six rate cuts from the ECB this year, which could see interest rates falling to 2.26% by the end of the year.
When interest rates go up, banks can see their net interest income go up too. In fact, net interest income for banks in the currency bloc increased 24% year on year in the second quarter of 2023.
The increase in net interest income helped boost return on equity significantly for banks in the currency bloc to 10.04% in quarter two, up from 7.59% in the second quarter of 2022. Along with a decrease in impairment and provisions, these were the main drivers of an increased net profit for European banks in the first half of 2023.
Net interest income has driven banking sector profits in the Eurozone in 2023, but, this support could wear down in 2024.
Financial markets are pricing in more than six rate cuts from the ECB this year, which could see interest rates falling to 2.26% by the end of the year.
So, banks in the currency bloc might not be able to get the same net interest income they did in 2023, and profits at European banks could be affected.
Economic growth forecasts also predict a challenging macro backdrop for European stocks in 2024. Bloomberg’s recession probability calculator has a 65% chance of recession for the currency bloc in 2024 – this compares with a 60% chance of recession for the UK and a 50% chance for the US.
Could we see a European recession?
There are additional risks for European stocks in 2024, aside from the prospect of a recession.
Firstly, operating margins for European stocks hit record highs in 2023, which might not be replicated in 2024.
Secondly, weak growth in China and thirdly, less exposure to artificial intelligence, which was a key driver of US stocks in 2023.
Risks from China are worth noting since European stocks with China exposure underperformed the overall Eurostoxx index in 2023. Without any clear sign that China’s economic prospects will improve in 2024, European exporters might not be able to rely on China in the coming months.
It's worth noting that Italian, German, and Spanish stock indices had started to flatline in the last few weeks of 2023 – a sign that investors might be starting to re-think their European positions in the new year.
But it’s not all doom and gloom. Italian stocks were the surprise winner of 2023, so there might be more upside for European indices in 2024.
3 reasons to be excited about Europe
There are reasons to be cheerful – relative valuations, the dividend ratio, and the currency effect.
European stocks are cheaper than US counterparts, even after the stellar performance in 2023. The one-year forward price-to-earnings (PE) ratio for the Eurostoxx 50 is 12.65, for the Dax it’s 11.87, for the Ibex 35 it’s 10.63 and 8.09 for the FTSE MIB.
This compares with a one-year forward PE ratio for the Nasdaq of 31.53 and 21.5 for the US blue-chip index. Even the Dow Jones Industrial index, which has less tech than other US indices, has a one-year forward PE ratio of 20.79.
There’s also the potential increase in the dividend ratio for European stocks. The dividend pay-out ratio, the fraction of net income a company pays to its stockholders as dividends, has trended lower in recent years and was 45.35% in 2022.
That’s much lower than recent years, with the dividend pay-out ratio at 107% in 2020, 63% in 2019 and 55% in 2018. So, there could be the potential for dividends to increase in Europe, which is one way to lure investors – of course, this isn’t guaranteed though.
Dividend payout ratio %
Lastly, the currency effect is also worth watching.
The largest companies in the Eurostoxx 50 include chipmaker ASML, luxury goods giant LVMH, and Total Energies, which together make up nearly a fifth of the Eurostoxx 50 index.
Each of these multinational companies earn big chunks of their earnings overseas, and when the euro is strong this can weigh on earnings in foreign currencies.
EUR/USD gained 4.65% versus the US dollar last year. Some might think that it’s due a pullback in 2024, which could have a positive earnings effect for European corporates.
The takeaway for European stocks?
The outlook is mixed for Europe in 2024, but, European stocks were the surprise winners of 2023. And while there’s never any guarantees, there’s always a possibility that they could repeat this in the coming months.
Kathleen Brooks is the Founder of Minerva Analysis, a market analysis company. Hargreaves Lansdown may not share the views of the author.