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The unfulfilled potential of Europe’s stock markets

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The S&P 500’s record-breaking start to the year was followed last week by the Stoxx Europe 600, which hit an all-time high and surpassed its previous peak in January 2022. Stock watchers are used to European equities being pipped to milestones by fast-growing American indices. Between 2009 and 2023, cumulative S&P 500 gains were five times those of the Euro Stoxx 50, a eurozone blue-chip index, in local currency terms. Businesses still dream of listing in New York, not Paris or Amsterdam. US stock markets are deeper and more liquid, investors tend to be less risk averse, and regulation is less onerous.

Yet fund managers still sense a buying opportunity. European shares are trading near a record discount to stocks in America, where a stronger tech sector has driven price growth since the global financial crisis. European banks are also set to return over €120bn to shareholders via buybacks and dividends, after bumper earnings from high interest rates. And while the eurozone is suffering from weak economic growth, the unwinding of its energy price shock and the prospect of interest rate cuts by the European Central Bank may buoy investors.

The European market offers something different. It has a range of defensive and growth stocks, including banks, pharmaceuticals and luxury retailers. The “Granolas”, a recently coined acronym for Europe’s 11 best performing stocks, include the global obesity drug market leader, Novo Nordisk, chip technology company ASML and the food giant Nestlé. They have matched the total returns of Wall Street’s Magnificent Seven tech stocks since the start of 2021. Though the Granolas dominate European markets to the same extent that the likes of Apple, Amazon and Nvidia do in the US, they are a more diverse bunch.

This means European companies can be an important diversifier in portfolios. They tend to be more global too. Around 60 per cent of European company sales are outside Europe, whereas many US firms are more focused on domestic markets. Investors are piling into stocks of European luxury goods with exposure to China, for example, as tensions between Washington and Beijing run high.

Yet the EU’s stock markets can and should strive to be more than just an alternative to American tech. Companies are too reliant on banks for funding. A bigger, deeper and more integrated European equity market would help its businesses to grow and absorb costs better, and unlock economic growth across the continent.

First, the EU must expedite its long-standing efforts to consolidate its fragmented capital markets. It has numerous exchanges, clearing houses and a patchwork of national securities laws. Harmonisation could unlock trillions of euros in deeper and more liquid pools of capital, which could support equity valuations and attract IPO activity. Second, the 27-nation bloc needs to mobilise more of its financial firepower from pension funds and retail investors. EU households keep a third of their financial assets in cash, estimates New Financial, a think-tank. An extra €1.8tn — 11 per cent of EU gross domestic product — could be generated if they raised their allocation to capital investments by 5 percentage points, it adds.

Third, it needs to revamp its image. The bloc has a reputation among investors for being over-regulated and unsuitable for start-ups seeking to scale. But it does produce innovative enterprises. Just this week, Microsoft struck a partnership with Mistral, a French AI start-up. A better connected European market would go some way towards reducing the red tape, while freeing up capital for start-ups.

With the demands of the climate transition and tech competition, Brussels remains committed to the idea of a capital markets union. But politics remains a sticking point. EU leaders are struggling to agree on the terms and conditions. Until they do, European stock markets will remain in America’s shadows — and well below their potential.

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