Europe's Stock Market Is Just As Concentrated As The U.S.

By Michael Msika, Bloomberg Markets Live reporter and strategist

The US equity market isn’t the only one with a heavy dependence on a handful of stocks. A positive start to the year in Europe has been down to mostly just three big caps — a concentration that some see as an opportunity.

Investors in the region have created their own version of the Magnificent Seven tech giants, with returns for the benchmark so far this year driven by bullish bets on three big names: ASML, Novo Nordisk and SAP. Without gains for the trio — which are all up at least 20% — the Stoxx 600 wouldn’t be in the green. It’s unusual for the regional benchmark, which is much more diversified than the S&P 500, with no stock exceeding a 3.5% weighting.

“Today, a group of very large market capitalizations enjoys dominant positions in products whose demand is exploding internationally,” says Syz chief investment officer Charles-Henry Monchau. He lists ASML in semiconductors, SAP in software, LVMH and Hermes in luxury goods, L’Oreal and Nestle in consumer goods, and Novo Nordisk, Novartis, Roche and AstraZeneca in health care.

“Going forward, we believe that European stocks might continue to perform well even if Eurozone growth disappoints. This is due to the superior business models of the aforementioned companies which should be seen as global champions rather than euro-centric ones,” Monchau says.

The high market concentration seen in Europe so far this year may be an opportunity, according to some. The trend toward large global champions seems likely to continue with a monetary policy shift, multiple elections and geopolitical instability all on the cards for 2024. That would make the Euro Stoxx 50 the best concentration play, with ASML, SAP and LVMH together accounting for more than 20% of the index and nearly 100% of its returns year-to date.

“The more cyclical tilt on SX5E Index, high index weight concentration, higher growth and momentum factor loading could result in SX5E delivering excess upside return versus the SXXP Index in the near term,” say JPMorgan derivative strategists led by Davide Silvestrini. They recommend buying outperformance calls on the Euro Stoxx 50 vs the Stoxx 600 as a leveraged play on the upside, should the earnings momentum for the top three performers continue.

The concentration of returns in a few names also has a direct impact on sectors — creating a dramatic performance gap this year. Tech is up 10%, while miners are down 8%, indicating clear investor preference for growth stocks as bond yields are expected to fall. Health care and staples outperforming also underlines a flight to defensive quality shares.

To be sure, reliance on a few large caps carries its own dangers: ASML’s stellar gains have been underpinned by the artificial intelligence boom, but it still faces risks in China, while Novo Nordisk is up against rising competition and issues with producing enough of its blockbuster drugs.

Deutsche Bank strategists Maximilian Uleer and Carolin Raab prefer sectors that seem less overbought after last year’s rally, can benefit from rates coming down and have the potential to turn from negative to positive earnings growth. They are overweight staples and telecoms and underweight utilities among defensives, and overweight chemicals vs underweight industrials in cyclicals.

Longer term, they see basic resources increasingly attractive after their weak performance last year, and as an essential sector for the energy transition. “We remain constructive on equity markets but expect little directional impulse tactically. Investing into relative trades is likely to yield higher upside than chasing directional market moves,” they say.