While investors’ attention remains largely focused on US technology, European equities are continuing their quiet revolution. With a return of around 10% in the first half of the year, they have once again demonstrated their considerable resilience in a macroeconomic environment broadly affected by the shock of the conflict in the Middle East.
This resilience is largely due to a wave of investment (capex) on a scale not seen for multiple decades, which is affecting multiple sectors of the economy simultaneously. Artificial intelligence, electrification, infrastructure and defence are all catalysts that are already driving the business of many companies.
Even more than their scale, these investments stand out for their duration. Driven by imperatives of sovereignty, energy security and competitiveness, they offer many listed companies exceptional visibility, regardless of the traditional economic cycle. In our view, this combination of four supercycles is one of the main drivers of European equities for the years to come.
Beneath the surface of a domestic economy that has virtually ground to a halt, a two-speed Europe is taking shape: on the one hand, a Europe that is stalling, with depressed consumption, residential construction at an all-time low and sectors such as the automotive and chemicals industries in dire straits; on the other, a Europe driven by powerful megatrends that are underpinning corporate earnings (which expected to rise by 17% this year despite sluggish GDP growth).
“The current four supercycles of AI, electrification, infrastructure and defence may be merely the first stage of a broader trend towards reinvestment in the real economy.
Game-changing investment supercycles
The drivers lie primarily in the combination of four investment supercycles that are either already in place or gaining momentum:
1. Artificial intelligence: The capex boom driven by US hyperscalers is benefiting the entire global value chain. Several European players, including ASML, Besi, Prysmian and Schneider, occupy a strategic position within this sector thanks to their global leadership in semiconductor equipment, cables and electrical infrastructure.
While the first wave of construction has mainly taken place in the US, investment is expected to gradually extend to Europe. The European Union has therefore set itself the target of tripling its data-centre capacity in the coming years.
2. Electrification: At the crossroads of climate, industrial and geopolitical challenges, this is now a strategic priority for Europe. By 2030, European electricity demand is expected to rise by more than 10%, representing an additional 300 terawatt-hours – the equivalent of Italy’s annual consumption.
Admittedly, data-centres are expected to account for around 10% of the growth in electricity demand according to the International Energy Agency, but they are clearly not the main driver of electrification. The need for investment in the grids was already considerable before the rise of AI, driven by transport, industry and heating, and has only been exacerbated by recent geopolitical tensions.
The main challenge no longer lies in electricity generation itself but in adapting the grids. These will need to be modernised, digitised and reinforced in order to integrate more decentralised and variable power flows. According to the European Commission, more than €1,200bn (£1,024bn) in investment will be required by 2040, representing a doubling or even a tripling of the current rate.
3. Infrastructure: Whether it be the new energy corridors that need to be redesigned in the wake of the war in Ukraine, water networks, transport infrastructure or ageing bridges and tunnels, the investment needs here are considerable.
Germany’s €500bn plan over 12 years is emblematic of this trend, but it forms part of a much broader movement. The NextGenerationEU and RePowerEU programmes, along with numerous national initiatives, are already supporting the roll-out of projects across the continent – notably in Italy, the Netherlands and Eastern Europe.
After several decades of underinvestment, physical infrastructure is now seen as a matter of both competitiveness and sovereignty. This need for modernisation provides sustained support for businesses active in construction, materials and services.
4. Defence: With expenditure in this area potentially reaching 3% of GDP – or even 5% when dual-use civil and military infrastructure is included – Europe is embarking on an investment drive that should provide long-term support for the growth of industrial, technology and defence companies for decades to come, even if the Russia-Ukraine war were to end.
The question of how to finance these investments is, of course, central. Governments will not be able to shoulder such an effort alone. The use of joint European funding could therefore continue to develop – possibly within the framework of the much-desired Capital Markets Union – to access and better channel European savings.
The private sector is also a vital part of this equation. With a record €1,500bn of annual deployed cash, European companies (STOXX 600 ex-financials) have a significant investment capacity. Investment expenditure by European industrials companies could grow by 4.5% per year by 2029 – a rate well above the historical trend of +0.5%, according to Goldman Sachs analysis.
New cycles already forming
Without necessarily speaking of new ‘supercycles’, new investment cycles could emerge around certain links in the value chains. As bottlenecks arise and issues of strategic dependence intensify, certain sectors could in turn benefit from an acceleration in investment, sometimes supported by more favourable regulation.
To meet the needs of electrification, infrastructure and defence, Europe will need to secure its supply of strategic raw materials. The production of copper, steel, lithium and rare earths is therefore expected to play an increasingly important role. The entire value chain is affected: extraction, refining, processing and recycling. Certain recent regulatory developments – particularly those favouring the European steel industry – already illustrate this growing awareness.
Energy production could also see the emergence of a new investment cycle that could benefit players in the oilfield services sector. Geopolitical tensions in the Middle East have served as a reminder of the importance of geographically diversifying supplies and have highlighted the consequences of several years of underinvestment.
Finally, after years of successive delays, the ageing of European production equipment has reached levels in certain sectors that are difficult to sustain. Whether it be aircraft fleets, industrial vehicles, construction equipment or certain types of medical equipment, many assets will need to be replaced over the coming years. In other words, the four current supercycles may be merely the first stage of a broader trend towards reinvestment in the real economy.
How should one invest in this transformation?
The market consensus has already largely settled on the main beneficiaries of these themes. Defence was the first sector to surge, before pausing while awaiting the fulfilment of order books. Companies in the semiconductor, electrification and utilities sectors then followed suit. Much of the market’s exposure to these themes is now reflected in valuations that leave little room for disappointment regarding the pace of growth or the execution of projects.
Occasional rotations towards high-quality stocks that have remained on the sidelines of these megatrends – such as those in consumer goods, software or real estate – would therefore come as no surprise. However, these movements should not undermine the underlying momentum. The megatrends are in full swing and continue to provide sustained support for the results of the companies involved, as well as their long-term stockmarket performance.
In this context, selectivity will be crucial. The major investment themes are now largely recognised by the markets, but the future beneficiaries are much less so. The most attractive opportunities could emerge within value chains – in companies whose exposure to these supercycles remains underestimated. Stockpicking therefore appears to be the best way to capitalise on this transformation.
Small and midcaps also represent particularly fertile ground. Often less closely monitored and more attractively valued than large caps, they frequently occupy essential niche positions within European and global industrial value chains. Their exposure to these various investment cycles offers potential that is still insufficiently recognised by the market.
A new era of investment is emerging, and future major investment cycles could thus be more firmly rooted in the physical world – that is, industry, advanced materials, defence, infrastructure or energy – where Europe possesses real strengths.
More fundamentally, these dynamics could mark a paradigm shift by restoring strategic value to certain assets, infrastructure and industrial know-how that investors had gradually ceased to value. Might the big surprise of this decade be that Europe’s ‘old economy’ could once again become, at least in part, an asset for the future?
Caroline Gauthier is co-head of equities at Edmond de Rothschild Asset Management
