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Stock market returns during 2024 have been dominated by companies in the US, specifically mega-cap US stocks, a trend which has been extended by the recent election of Donald Trump as president. It might be easy against this backdrop to overlook the European small cap segment of the market, where the JPM European Discovery Trust (JEDT) plies its trade. However, if one takes a longer-term view, there are plenty of reasons to be excited about European small caps.
Firstly, the long-term performance of European small caps rivals that of any equity market segment. Since 1999, the MSCI Europe (ex UK) Small Cap Index has returned roughly 10% a year on a compound annual basis, which means that in the past 25 years, European small caps have grown almost 10x, compared to just 3x for large caps.
Source: J.P. Morgan Asset Management, Bloomberg.
This gulf in performance can be explained quite simply, it is just the difference in earnings growth. Smaller cap stocks, often at the start of their growth journey, can more easily take bigger leaps in size versus the larger cap peers. Short-term variances in performance can sometimes distort this trend, but the JEDT portfolio managers feel the dynamic is not going to change in the long term.
In contrast to many areas of the US market, European small caps are currently cheap, based on historical valuations. Moreover, they are trading at a discount to large cap stocks, which given their greater earnings growth potential, displays an opportunity.
Source: J.P. Morgan Asset Management, Bloomberg. ESC = MSCI Europe Small Cap Index. Europe = MSCI Europe Index. Data as of 30 September 2024. CAPE: Cyclically adjusted price-to-earnings refers to the current price divided by the 10 year moving average of earnings, adjusted for inflation. The purpose of this is to smooth out fluctuations in corporate earnings that can distort shorter-term measures.
The drivers of this valuation gap have been a numbers of consecutive crises; Covid-19 pandemic, the Russian invasion, and the inflation burst. These factors combined to push investors into large cap stocks, which are seen as relatively safer during times of uncertainty.
Another significant factor is higher interest rates, which central banks raised to combat spiralling inflation in the eurozone. These higher interest rates also served to slow the domestic economy, which small cap companies are relatively more exposed to. Furthermore, small cap companies tend to have higher levels of debt and lofty interest rates make it more expensive to service that debt.
The portfolio managers believe that valuations have become overstretched and there are a number of factors that are turning in favour of small caps. One of the main factors is the normalisation of interest rates in the eurozone. The European Central Bank has already started its rate cutting cycle, with the latest 25 basis point cut delivered in the Bank’s December meeting. These reductions in interest rates not only alleviate some of the interest rate burden for corporates, but also strengthen economic conditions.
There are already some signs of an improving environment for consumers. Purchasing power is improving, with real wages on the rise, while consumer confidence is hovering around its highest levels since early 2022. Given their sensitivity to the domestic economy, this bodes well for small cap companies.
Source: J.P. Morgan Asset Management, Bloomberg. Data as of 30 August 2024.
This isn’t to say that the picture for the European economy is universally strong. The manufacturing sector has been a large drag on growth, highlighted by the high profile issues in the German autos sector. This is why it is important to be selective when investing in European small cap.
The strategy behind the European Discovery Trust prides itself on stock picking rather than macroeconomic forecasting. It focuses on finding exceptional businesses, that are attractively priced and have strong long-term prospects.
One such company that the portfolio managers feel is right at the start of its growth trajectory is Finnish DIY retailer Puuilo. The company currently operates around 40 stores, but has ambitions to double its network over five years. This approximates to opening two stores every quarter.
Additionally, several small companies within the European market are demonstrating remarkable innovation. Danish biotech company Zealand Pharma has an exciting pipeline of treatments for obesity and diabetes that the portfolio managers believe can rival that of larger cap peer Novo Nordisk.
While recent focus has been on mega-cap US stocks, European small caps present a compelling long-term investment opportunity. Historically, they have delivered strong returns, and the current valuation gap with large caps highlights their potential. As interest rates normalise and consumer confidence improves, conditions are becoming favourable for small cap growth.
The JPM European Discovery Trust leverages this potential through strategic stock selection, focusing on companies with strong growth prospects and innovation. This positions European small caps as an attractive option for investors seeking diversification and growth in a dynamic economic environment.
Past performance is not a reliable indicator of current and future results.
Source: J.P. Morgan Asset Management/Morningstar. Net asset value performance (NAV) data has been calculated on a NAV to NAV basis, including ongoing charges and any applicable fees, with any income reinvested, in GBP.
NAV is the cum income NAV with debt at fair value, diluted for treasury and/or subscription shares if applicable, with any income reinvested. Share price performance figures are calculated on a mid market basis in GBP with income reinvested on the ex-dividend date. The performance of the company's portfolio, or NAV performance, is not the same as share price performance and shareholders may not realise returns which are the same as NAV performance.
Comparison of the Company's performance is made with the benchmark. The benchmark is a recognised index of stocks which should not be taken as wholly representative of the Company's investment universe. The Company's investment strategy does not follow or track this index and therefore there may be a degree of divergence between its performance and that of the Company. Prior to 01/04/20 the benchmark was Euromoney Smaller European Companies (ex UK) Total Return Index.
Summary Risk Indicator
The risk indicator assumes you keep the product for 5 year(s). The risk of the product may be significantly higher if held for less than the recommended holding period.
Trust Objective: The Company aims to provide capital growth from a diversified portfolio of high-quality smaller companies in Continental Europe. As the emphasis is on capital growth rather than income, shareholders should expect the dividend to vary from year to year. The Company has the ability to use borrowing to gear the portfolio within the range of 20% net cash to 20% geared, in normal market conditions. Gearing may magnify gains or losses experienced by the Company.
Key Risks: Exchange rate changes may cause the value of underlying overseas investments to go down as well as up. External factors may cause an entire asset class to decline in value. Prices and values of all shares or all bonds and income could decline at the same time, or fluctuate in response to the performance of individual companies and general market conditions. This Company may utilise gearing (borrowing) which will exaggerate market movements both up and down. This Company invests in smaller companies which may increase its risk profile. The share price may trade at a discount to the Net Asset Value of the Company.
This is a marketing communication and as such the views contained herein do not form part of an offer, nor are they to be taken as advice or a recommendation, to buy or sell any investment or interest thereto.
Reliance upon information in this material is at the sole discretion of the reader. Any research in this document has been obtained and may have been acted upon by J.P. Morgan Asset Management for its own purpose. The results of such research are being made available as additional information and do not necessarily reflect the views of J.P. Morgan Asset Management. Any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are unless otherwise stated, J.P. Morgan Asset Management’s own at the date of this document. They are considered to be reliable at the time of writing, may not necessarily be all inclusive and are not guaranteed as to accuracy. They may be subject to change without reference or notification to you. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Changes in exchange rates may have an adverse effect on the value, price or income of the products or underlying overseas investments. Past performance and yield are not reliable indicators of current and future results. There is no guarantee that any forecast made will come to pass. Furthermore, whilst it is the intention to achieve the investment objective of the investment products, there can be no assurance that those objectives will be met. J.P. Morgan Asset Management is the brand name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. To the extent permitted by applicable law, we may record telephone calls and monitor electronic communications to comply with our legal and regulatory obligations and internal policies. Personal data will be collected, stored and processed by J.P. Morgan Asset Management in accordance with our EMEA Privacy Policy www.jpmorgan.com/emea-privacy-policy. Investment is subject to documentation. The Annual Reports and Financial Statements, AIFMD art. 23 Investor Disclosure Document and PRIIPs Key Information Document can be obtained in English from JPMorgan Funds Limited or at www.jpmam.co.uk/investmenttrust. This communication is issued by JPMorgan Asset Management (UK) Limited, which is authorised and regulated in the UK by the Financial Conduct Authority. Registered in England No: 01161446. Registered address: 25 Bank Street, Canary Wharf, London E14 5JP.
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