Around this time last year, Europe’s leaders were scrambling. The Russia-Ukraine war and resulting sanctions had disrupted the flow of natural gas to the Continent, and there were mounting concerns that spiking energy prices would have dire consequences. China seemed set on maintaining its pandemic closures, limiting the demand from one of the chief recipients of European exports. Eurozone inflation had ratcheted up to alarming levels, nearing 9% in June on its way to a September peak of 10.6%.

However, decisive government action, impressive solidarity among nations and old-fashioned good luck seem to have headed off the worst outcomes. A combination of government subsidies, the securing of new sources of natural gas and a particularly mild winter staved off the energy crisis. China ended its pandemic restrictions in January after domestic anti-lockdown protests. Inflation has started to fall as energy prices have dropped sharply.

Altogether, the region has had an unexpected turnaround in its fortunes.

“The eurozone economy has been surprisingly resilient over the past 18 months,” says Capital Group economist Robert Lind. “Fiscal support and tight labor markets underpinned consumer spending, and there has been a notable improvement in investment spending.”

There’s reason for continuing optimism. After years of stagnation or outright decline in many European countries, investment, both public and private, is increasing again. The NextGenerationEU recovery fund, which was approved in late 2020 and provided immense help during this period of stress, is designed to provide aid over the next several years. The European Central Bank forecasts that inflation will fall toward its target of 2% this year and next. 

Those macro dynamics are joined by a handful of equity-specific factors that could reward investors. European valuations remain below recent averages, suggesting there are still compelling values among well positioned companies. The post-pandemic period continues to unfold, giving many industries a chance to grow in the near term. And the U.S. dollar has weakened against the euro since last year, which can provide a currency translation boost to U.S. holders of eurozone securities.

Of course, not everything is positive. Economic activity has stagnated recently and survey data suggest business sentiment among European industrials is weakening. Some countries are faring worse than others, particularly the economic powerhouse of Germany, which has been in a recession of its own. And housing is weakening as interest rates rise. The ECB is still on course to push its interest rates to their highest since the global financial crisis.

Still, many factors suggest a long-term positive outlook for the region and opportunities for investors.

Europe’s resilience has been multifaceted.

The last major test of eurozone strategy and solidarity was the Continent’s debt crisis in the 2010s. That period was marked by infighting among countries and punitive austerity measures that aggravated underlying conditions and prolonged economic pain. Today, by contrast, the bloc has displayed far more cohesion and avoided the worst effects of the global pandemic and devastating war in Ukraine.

“European policymakers have been pragmatic,” Lind explains. “They learned the lessons of the mistakes of the 2010s. They reacted very quickly during COVID and the energy shock.”

Lind says three major prongs to the response likely helped soften the blow.

First, he cites the solidarity policymakers showed in facing the natural gas shortage caused by the Ukrainian war. Not only were countries quick to subsidize the abruptly skyrocketing costs pelting businesses and households, but the bloc as a whole quickly moved to support individual nations.

Additionally, “the response to the energy shock was a much more significant behavioral change, in terms of energy demand and consumption, than we might have expected,” Lind says. And it wasn’t just states that contributed: Consumers and businesses were willing to limit their consumption even though their governments had intervened to absorb some of those costs.

Second, governments have been far more willing to offer fiscal support than in the past. This has provided a significant buffer to households and the broader private sector, a major shift in approach, and it will likely extend beyond the current crises, Lind says.

“The attitude toward government intervention to help the economy is a significant change, and it applies to more than just immediate emergencies,” he says. The recovery fund is a perfect example. The plan not only addresses pandemic needs, but it includes funds earmarked to help ease countries through major structural changes, particularly around energy consumption.

Finally, he cites the strength of the eurozone consumer.

“I think there has been a change in what economists call ‘animal spirits,’ or expectations of behavior,” he notes. “People emerged from the other side of the pandemic with significant savings, and I think there’s a much greater willingness to spend money on things like travel and tourism.”

To be sure, there are signs of a slowdown in the European economy. The recently declared recession, as mild as it has been, still represents at best essentially flat gross domestic product, or GDP, and higher interest rates are causing difficulty for the housing market. But those are not markers of an inevitable sharp decline, Lind says.

“At the moment, those difficulties could simply be adjustments to the post-pandemic period,” he says. “In a lot of ways, the trajectory of this economy resembles the U.S. recovery, albeit less dramatic. It’s simply doing better than we might have expected.”

Many equities appear poised to do well over time.

Perhaps reflecting the region’s stamina, European stocks have had a strong run this year. However, valuations in many sectors remain below their long-term averages, and additional tailwinds suggest there’s more room for growth.

For example, the U.S. dollar has weakened significantly against the euro and other global currencies since October. The greenback had been overvalued on several metrics for many years, but in recent months signs have suggested that this might be changing. In periods of dollar weakness, that falling exchange rate can significantly boost total returns from equities denominated in other currencies.

Other developments could bode well for specific industries. For example, China’s full reopening in January could be a shot in the arm for Europe’s export-heavy economy, including luxury brands that have become increasingly dependent on the country. Some of them are already seeing the effects of China’s reopening, with LVMH and Hermès reporting strong first-quarter results. Additionally, re-establishing some of these brands’ pre-pandemic global reach could help insulate them from slowdowns closer to home.

Similarly, European households appear primed to increase spending, thanks to well-stocked savings accumulated during the COVID-19 lockdowns and a boost to real incomes as lower energy prices feed through to falling inflation rates. That could give large consumer goods companies a window to raise prices. Not only would that help defray the companies’ own rising costs for raw materials and services, but price increases could expand margins and profitability.

Many European companies are perched on the edge of innovation.

While many tech companies are based in the U.S., Europe has its fair share of businesses that could benefit from the corporate world’s escalating need for computing power. Semiconductor demand continues to rise due to the hunger for high-performance chips that are used to power the cloud and artificial intelligence and enable the increasing digitization of automobiles.

Netherlands-based ASML, which manufactures highly specialized photolithography equipment, estimates that semiconductor industry revenue will reach $940 billion by 2030, doubling from 2020. Companies that fill important niches are likely to remain attractive investments even at relatively high valuations, Capital Group Private Client Services equity portfolio manager Gerald Du Manoir says.

Similarly, many cutting-edge pharmaceuticals are based in Europe. These companies have heavily invested in drug discovery, building deep pipelines of potentially pioneering treatments that seek to address major health issues. Recent success stories include powerful new weight-loss drugs and oncology treatments, though Du Manoir notes that thorough research is essential to understand the companies’ clinical prowess and the competition they might face.

“Some of these drug stories can become overly enthusiastic,” he says, because they can seem so promising in the moment. However, it’s important to make sure the companies are continuing to look forward and research new products. “I always look for business models that could be promising in a world where profit is more important than revenue.”

With pandemic restrictions nearly over, travel beckons again.

Air travel is picking up in a post-pandemic world and should get a big boost from China fully ending its restrictions. Travel is a secular growth industry in a lot of countries, and demand is rising for new airplanes. There’s also opportunity in emerging markets, where the middle class is growing, and air travel is still in its relative infancy.

More than 39,000 new aircraft are projected to be built by 2040, according to Airbus and Boeing, which dominate the market. While U.S.-based Boeing specializes in wide-body aircraft, Europe’s Airbus leads in midsize planes used for short-haul flights — the segment experiencing the fastest growth. European companies also build engines and components, as well as landing gear; Paris-based Safran is the world’s largest maker of engines for single-aisle planes.

The dynamics of aircraft orders benefit manufacturers. Airlines pay in installments and have prepaid most of the cost by the time planes are delivered. Given today’s large backlog of orders, buyers don’t want to lose their place in line. This provides a strong baseline for forecasting the manufacturers’ cash flows and revenue.

Dividends are an important area of focus in Europe.

Today, Du Manoir says he sees evidence that the corporate commitment to paying dividends is greater than ever.

“Returning cash to shareholders is being looked at by more companies around the world than I’ve ever seen in my investment career,” he says. “Many management meetings are putting the emphasis on giving back to shareholders.”

That could be a boon for investors interested in steady returns and defensiveness, traits that are often associated with dedicated dividend payers. However, Du Manoir cautions that dividends themselves aren’t necessarily strong markers of resilience. The key is payouts consistently made over time, in balance with a company’s other obligations, he says.

“One thing we need to be careful about is the intellectual shortcut of saying companies that pay dividends are defensive,” he explains. “Companies that can sustain their dividends through the earning cycle are more likely to be defensive. It’s an important subtlety, but it’s important to finding good, slow-burning returns.”