The German share price index DAX graph is pictured on the stock exchange in Frankfurt, Germany, January 19, 2024.
Staff | Reuters
Over the past 12 months, just 11 stocks made up half of the gains that powered the pan-European Stoxx 600(*7*) stock index to a record-high close on Friday.
Earlier this month, Goldman Sachs(*7*) highlighted that Europe’s stock markets were dominated by this group of “internationally exposed quality growth compounders” with the continent’s largest market caps, which the bank termed the GRANOLAS back in 2020.
The momentum of this group — which comprises GSK(*7*), Roche(*7*), ASML(*7*), Nestle, Novartis, Novo Nordisk, L’Oreal(*7*), LVMH(*7*), AstraZeneca, SAP and Sanofi(*7*) — has drawn comparisons to the “Magnificent Seven” U.S. tech giants and evoked similar concerns about concentration risks in European equity markets.
Together, the GRANOLAS account for around 1 / 4 of the whole Stoxx 600 market cap, and Goldman analysts in a note last week highlighted that they exhibit qualities which are expected to thrive in the present cycle, similar to solid earnings growth, high and stable margins and powerful balance sheets.
“We expect in addition they stand to profit from the structural shift towards passive investment and the shortage of liquidity within the European equity market,” the Wall Street bank’s analysts suggested.
“From a Global perspective, the GRANOLAS have even outperformed the so-called Magnificent 7 over the past two years. Their (out)performance is much more impressive on a risk-adjusted basis: with a volatility 2x lower than for the Magnificent 7, the GRANOLAS help to boost the Sharpe ratio.”
They noted that, while the group trades with a high price-to-earnings ratio, a measure that gauges whether a stock is overvalued, that is “commonplace for growth firms” and the GRANOLAS actually trade at a major discount compared to the Magnificent Seven.
What’s more, Goldman Sachs expects the strong growth momentum to proceed, with a 7% revenue compound annual growth rate expected for the GRANOLAS through 2025, compared to 2% for the broader market excluding the group. The 11 stocks also provide dividend yields for shareholders within the 2-2.5% range.
“This implies that, in Europe, nearly all revenue growth of the STOXX 600 will come from the GRANOLAS. We expect this can be sustained by high barriers to entry businesses, solid balance sheets and high investment — they reinvest the identical share of money flows in R&D and growth CAPEX because the Magnificent 7,” Goldman Sachs added.
Such a high and potentially deepening concentration of stock market gains gives rise to concerns about concentration risk, but some analysts consider that the varied sectors represented within the group may insulate the GRANOLAS to some extent.
Tim Hayes, chief investment strategist at Ned Davis Research, told CNBC on Monday that, for recent comparisons to the present state of play, market participants should look to the top of 2020, when the market was highly concentrated around a small variety of large-cap stocks.
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“What happened then was the market broadened out and this brought us into 2021 which turned out to be a superb yr, very low volatility — we also had the market broaden out in anticipation of what turned out to be a globally synchronized economic expansion, earnings growth was coming through globally across sectors,” Hayes said.
He suggested this created “a number of complacency” out there, which prompted investor confidence to linger despite emerging “divergences” beneath the surface.
“That is what created that very narrow market at the top of 2021, because an increasing number of sectors began to diverge as we began to see signs of those supply chain pressures and the inflationary pressures, commodity prices moving higher, all of the things that got us into the 2022 bear market,” Hayes added.
While this doesn’t necessarily have to be a negative indicator at once, he suggested that the longer the present complacency lingers, the more vulnerable the market is to bad news, or the excellent news that had been priced in failing to come through.
“We have seen this recently with the expectation that we’re going to have all these rate cuts, when it turned out, well, possibly we’re not going to have as many rate cuts because the market thought, that arrange somewhat little bit of a pullback,” Hayes said.
“That may occur on an even bigger scale if the market gets too complacent, and then you definitely’re more vulnerable to some form of negative surprise entering the image.”
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