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Last Wednesday's market sell-off was the worst we've seen since 5 August, and the similarities didn't stop there. Nvidia (NVDA) and other chipmakers led the path downward, losses which have been echoed by European AI darlings Arm Holdings (ARM) and ASML (ASML), both of which are down 10% in the last week.
When the August 5 sell-off occurred, we were quick to point out that markets were actually slightly undervalued, and that economic conditions were in fact improving. Thus, investors should be embracing the opportunity to top up equity exposure at a reduced price.
Luckily for us, this recovery came about in swift fashion, with markets broadly recouping the losses within a couple of weeks of the sell-off. The big question is: has anything changed since then, and should investors be following the same strategy now?
European Stocks Remain Cheap
European equity markets are currently trading at close to a 6% discount to their fair value estimate. Have equity markets been cheaper in the past? Yes, but they are a long way from being expensive today.
On a sector basis the picture is more mixed. The healthcare and industrials sectors are very slightly overvalued, with other sectors broadly in-line with market valuation, at or around a 5% discount to their fair values. The largest valuation gaps are evident in areas like consumer discretionary and real estate, where sector-specific concerns are holding back valuations.
The Case for Rate Cuts Has Gotten Even Stronger
The macroeconomic picture has also changed since August's market rout as newer data on GDP growth and inflation came in — two key components in central banks' decision on future interest rate cuts, and therefore the key driver of equity markets in 2024.
In the second quarter of the year, GDP growth rose by 0.6% in the UK and by 0.3% in the Eurozone, not blow-out growth, but solid. Particularly when you take into account where we've come from. The UK entered a technical recession in 2023, with two consecutive quarters of negative growth, and the Eurozone only narrowly avoided this fate. Now, economists' forecasts are pointing to growth of around 1% for both regions for the full year 2024. This is most definitely a step in the right direction.
The second macro component we got more clarity on in August was inflation. After a slight spike in July, inflation rates across Europe fell again in August. In both the UK and the Eurozone inflation readings pointed to a 2.2% increase year-on-year, putting it within touching distance of the 2% target. We've come a long way from the near-double-digit rates of 2022, helped in no small part by the tighter monetary policy enacted by the Bank of England and European Central Bank.
So what does all this mean? Essentially the data released over the last month has been supportive of future, near-term, rate cuts. 85% of economists polled by Reuters are expecting the ECB to cut rates again this week. For the BoE, September is likely to come too soon for another rate cut, but economists are predicting two more rate cuts in November and December. Cumulative rate cuts are highly supportive of economic growth, and could lead to a further ramp up in growth across Europe next year, boosting equities.
Which European Stocks Are at Risk of a Tech Rout?
So where are the risks in Europe, and can the latest slide in US tech stocks lead to market contagion? The short answer is no.
In a screen for overvalued stocks in our European coverage universe we get fewer than 40 names. In the top 20 overvalued stocks in Europe we get just a single large tech name: Germany's SAP (SAP). The rest of the list is a diverse group of stocks, many of which are involved in industrial or manufacturing activities, in the cases of Siemens (SIE) and Rational (RAA), or indeed the luxury goods segment, Ferrari (RACE) and Hermes (RMS), for example. Therefore, European tech is not a weak point that could lead to a broader market rout.
In our book, most large tech names (which is where the rout started) are not overvalued. We believe ASML (ASML) is around 25% undervalued, while ARM Holdings (ARM) is trading at or around its fair value estimate. The European economy is weak, but moving in the right direction and further interest rate cuts are expected imminently. Pioneer investor Ben Graham once said that "in the short term, markets are a voting machine, and in the long term they are a weighing machine." Markets can be sentiment-driven, and short-term bouts of volatility may persist, but, for longer-term investors, now is not a bad time to be invested.
Michael Field is European market strategist at Morningstar
