Jim Lydotes: «There Are Hidden Gems in Europe»
This could be the time to take a closer look at European small-cap stocks, Jim Lydotes writes in an article on finews.first.
Inflationary pressures in Europe appear to be easing, and several economic indicators are at an inflection point. This shift could work in favor of active managers.
European small- and mid-cap stocks are currently in an attractive position for investors. As inflation cools and economic prospects improve, these previously overlooked companies become more appealing. Their valuations remain attractive compared to their U.S. counterparts, and evolving geopolitical dynamics create new growth opportunities. For investors seeking diversification, now could be the perfect time to explore them.
Favorable Macroeconomic Environment
European small and mid-caps have faced significant inflationary pressures in recent years. The sharp rise in energy prices, particularly following Russia’s invasion of Ukraine in 2022, posed a major challenge. However, the situation has since stabilized, as Europe has largely overcome its energy crisis.
For years, Europe's dependence on Russian gas and oil was a critical issue. However, as the region successfully reduces its reliance, inflationary pressures show clear signs of easing.
Eurozone inflation also appears to be stabilizing. In January, it stood at 2.5 percent, and some analysts expect it to fall below the European Central Bank’s 2 percent target within the next two years. Meanwhile, declining energy prices are providing relief to consumers.
Improved Sentiment
Other economic factors also support European small-cap stocks. These include improved consumer sentiment in the Eurozone and a more optimistic GDP outlook. If Europe follows through on the recommendations of the Draghi Report, the continent could boost its productivity and competitiveness.
Additionally, unemployment in the region is at a historic low, while wages have been rising. If Europe implements the recommendations of the Draghi Report, the continent could see gains in productivity and competitiveness.
Crucial Indicator
However, attractive valuations alone are not enough. Beyond favorable pricing, corporate earnings momentum is key. A crucial indicator is the trend in earnings estimates—if earnings expectations continue to rise, it signals improving market conditions.
Currently, Eurozone stocks appear inexpensive relative to the U.S. market based on price-to-earnings ratios. They are trading at valuation levels last seen a decade ago. Small-cap stocks in the region are now trading at nearly a 50 percent discount to the S&P 500.
Value Through Active Management
In the small-cap segment, active management plays a crucial role. Stock selection is particularly important, as the risks associated with small-cap investing are largely company-specific. A detailed analysis of individual businesses can help identify untapped value potential.
Governments and political parties worldwide increasingly adopt protectionist measures to safeguard their interests in global trade and supply chains. This shifting landscape calls for adjustments in investment strategies.
Companies with a strong domestic market focus stand to benefit the most from protectionist policies. Small caps, in particular, are often well-positioned in this regard. In periods of heightened trade barriers, businesses primarily focused on their home markets may gain an advantage over more globally oriented firms.
Jim Lydotes is the Lead Portfolio Manager of the BNY Mellon Small Cap Euroland Fund.
