Joice Alves, Danilo Masoni

LONDON, (Reuters) – A short month of war in Ukraine erased a whole year of gains in European equities. However, the continent’s bourses quickly recovered because investors have poured their money into sectors like energy and defense that stand to reap the benefits of one of the most significant policy shifts in this region for decades.

This is the most significant war in Europe since World War Two. It has awakened governments that their countries must reduce their dependence on Russia for oil and gas and develop their own security forces.

European stocks have come back quickly after initially falling to their lowest level in 12 months due to massive outflows from fears of a stagflation shock. German defense company Rheinmetall shares are now worth around twice what they were before the conflict, while Vestas Wind System shares have increased by 40%.

Markets in general have recovered 11% within a month and are close to a new record on January 4. Overall valuations are at 34% below the U.S. markets.

Benjamin Jones from Invesco, who is director of macro research said that the TINA argument (or “There is No Alternative”) to stocks is less convincing than it once was. But… the yields available on many areas of the equity space, particularly financials and energy, is still the best source for income.

Graphic: Europe PE discount to U.S.: https://fingfx.thomsonreuters.com/gfx/mkt/gdpzybzykvw/Europe%20PE%20discount%20to%20US.PNG

Since February 24, when Russia began a special military operation in Ukraine, the shopping cart of investors has been transformed.

Eric Lopez of BofA Global Research is the head of EMEA Equity Research. He stated, “Europe will be independent and redefine many sectors and economic paradigms”.

He said that “the consequences will vary from the development and acceleration of existing industries to the addition of infrastructure and technologies while attaining independence and leadership for others.” European Commission plans to increase liquefied energy, green power, storage, and replace Russian gas imports with its expensive REpowerEU program. According to BoFA, Europe’s regional investment flows are still in negative territory with net outflows this year of $17.9 million.

Morningstar data shows that there were 2.1 Billion Euros in European Energy Sector Fund Inflows this Year, and shares of some European Defence Companies have achieved double-digit returns from the start of war.

Graphic: European defence shares: https://fingfx.thomsonreuters.com/gfx/mkt/egpbkbexxvq/European%20defence%20shares.png

Germany and Sweden announced that they will increase defense spending to an average of 2% of their GDP.

BofA projects 200 billion euros (or 218.08 billion dollars) in annual incremental spending for the sector, if all European nations spend 2% of their gross national product on defense.

As oil prices rose, commodities-linked stocks and financials shares became the top sectors. For its defense qualities, healthcare is back in fashion.

Graphic: European sectors in 2022: https://fingfx.thomsonreuters.com/gfx/mkt/xmpjoqymgvr/European%20sectors%20in%202022.png

“SO AWAY WITH THESE INDEXES!”

Lale Akoner is a senior market strategist for BNY Mellon Investment Management (NYSE:) Investment Management. She stated her top picks as commodity-rich London or the Norwegian Index. Because of its high exposure to Russian energy, she is not interested in Germany’s.

“What I’m trying to tell clients is that they have to… understand the subtleties of which country is more dependent upon natural gas and/or energy supply from Russia,” she stated. These indexes should be avoided.

There is a lot of investor interest in Europe’s energy sector with the REPowerEU plan expected to be positive for pure renewables players like RWE, Orsted (OTC:) and EDP Renováveis.

Plans to speed up the development of alternative gas supplies and LNG will need supporting infrastructure, which could put E.ON, Italgas, Snam, Terna, Red Eléctrica and Enagás in the spotlight for potential network development.

Jones from Invesco stated that “what’s been happening in Russia and Ukraine all at once meant that the transition to renewable energy sources is no longer just an environment issue. It is now also a security concern.”