Europe Insights
Key Highlights:
While rate cuts are on the agenda for the ECB this year, the lagged effects of tight monetary policy are already evident in European markets and macro environment.
- Macro environment: New rate environment may benefit the construction sector in 2024, but a sustained recovery for the sector hinges on several other factors
- European equities: Improving borrowing conditions could support a reversal of small caps’ underperformance relative to large caps
- European bonds: Despite moderation, yields on investment grade bonds remain attractive, but a cautious and selective approach is warranted
Signs of recovery in construction sector amidst challenges
Rising energy, material and financing costs have weighed on the European construction sector over the past two years. Construction costs have now moderated and are anticipated to stabilise in the latter half of 2024, based on declining long-term yields. Amidst challenges, the construction activity, especially in Southern Europe, has shown resilience with policies providing crucial support. However, resolving elevated borrowing costs and regional disparities may potentially lead to a sustained recovery for the sector.
Small cap reversal on the horizon?
European small caps have historically outperformed large caps but have faced a setback in recent years. This is partially explained by their lower exposure to sectors that benefitted from rising rates and their heightened sensitivity to tightening borrowing conditions and economic uncertainty. However, borrowing costs have stabilised in recent months and, given the disinflationary environment, could fall further. This, coupled with low valuations and positive earnings growth prospects, could potentially lead to a reversal in the underperformance of small caps relative to their large cap counterparts.
European bonds are back
Expectations that the European Central Bank will cut interest rates later this year, along with solid corporate balance sheets, have driven robust performance by bonds over the first quarter. Although yields have consequently moderated, investment grade bonds are still attractive given carry and rolldown opportunities. However, lagged effects of tight policy and slowed earnings growth in Europe will weigh on European companies, which means investors should exercise caution in terms of sector and issuer selection.