Are European stocks vulnerable to an AI led by Nvidia…

European shares remain cheap

European equity markets are currently trading at a discount of almost 6% to their estimated fair value. Have stock markets been cheaper in the past? Yes, but they are very expensive today.

By sector, the picture is more mixed. The healthcare and industrials sectors are very slightly overvalued, with the other sectors broadly in line with market valuation at or around a 5% discount to their fair values. The biggest valuation gaps are evident in areas such as consumer discretionary and real estate, where sector-specific concerns are holding back valuations.

The case for rate cuts just got stronger

The macroeconomic picture has also changed since the market opened in August as newer data emerged on GDP growth and inflation – two key components in central banks’ decision on future interest rate cuts and thus the engine key stock 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 euro area, not explosive but solid growth. Especially when you consider where we come from. Britain entered a technical recession in 2023, with two consecutive quarters of negative growth, and the euro zone only narrowly avoiding this fate. Economists now forecast growth of around 1% for both regions for the full year 2024, certainly a step in the right direction.

The second macro component we got more clarity on in August was inflation. After a slight increase in July, inflation rates in Europe fell again in August. In both the UK and the euro zone, inflation readings indicated a 2.2% increase year-on-year, putting it within striking distance of the 2% target. We’ve come a long way from near double-digit rates in 2022, helped in no small part by the tightening of economic policies by the Bank of England and the European Central Bank.

So what does this all mean? In essence, the data released over the past month has supported future, near-term rate cuts. 85% of economists polled by Reuters expect the ECB to cut interest 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 interest rate cuts are largely supportive of economic growth and could lead to further growth in Europe next year, boosting stocks.

Which European stocks are at risk of a technical routine?

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 have only one big tech name – Germany’s SAP (SAP). The rest of the list is a diverse group of stocks, many of which are involved in industrial/manufacturing activities, in the cases of Siemens (SIE) and Rational (RAA), or even the luxury goods segment, Ferrari (RACE) and Hermes. (RMS), for example. Therefore, European technology is not a weak point that could lead to a wider market shift.

Most of the big tech names where this route started are not overrated in our book. We believe ASML (ASML) is around 25% undervalued, while ARM Holdings (ARM) is at or around its estimated value. The European economy is weak but heading in the right direction and further interest rate cuts are expected imminently. Pioneering investor Ben Graham once said that “in the short term the markets are a voting machine, and in the long term they are a weighing machine.” Markets may be driven by sentiment and short-term bouts of volatility may persist, but for long-term investors, now is not a bad time to be invested.