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This article was originally published in The Telegraph.

WELL, what a difference a year makes. Last May’s Eurovision in Turin was staged against a grim backdrop for Europe. The region was reeling from the invasion of Ukraine, oil and gas prices had soared, and talk was turning to recession. Unsurprisingly, investors were turning their backs on European stock markets. Between February and October last year, the pan-European index fell by 30%.

As this year’s follow-up in Liverpool gears up for Saturday’s finale, the only thing that remains the same is the tragic mess in Ukraine which as a result is unable to host the contest as last year’s winner. In every other regard, however, the picture in Europe is unrecognisable. From an investment perspective, the region has been transformed. Since October, the MSCI Europe index has risen by a third, twice as much as its counterparts in the US and here in Britain.

Six months ago, few would have predicted that Europe would be the leader of the pack. As winter loomed, the prospect of energy shortages and a sharp economic slowdown seemed to justify the poor performance of local markets. In fact, the night was darkest before the dawn.

What happened instead was that Mother Nature delivered an unusually mild winter, allowing storage tanks to be filled and energy prices capped at just about affordable levels. Meanwhile, on the other side of the world China decided, unexpectedly, to abandon its futile fight against Covid.

For an export-dependent region like Europe, President Xi’s U-turn could not have been better timed. The avoidance of what seemed like an inevitable recession, has boosted confidence in the outlook for the region’s companies. While forecasts continue to drift in the US, and recession in the world’s biggest economy remains probable, Europe is heading in the other direction. With about 60% of European companies having reported results in the first quarter earnings season, there has been an above-average number of positive surprises and a near-record low number of disappointments. Europe is the only region in the world where earnings are being revised higher.

In some ways Europe is a very different investment proposition than the US. It is much less focused on technology, much more exposed to global demand, more cyclical, more conservative when it comes to savings and investments, more open to environmental, social and governance considerations, more highly regulated and cautious.

But in one way its stock markets look very similar to those in the US - its concentration on just a handful of shares. In the US, the market is dominated by the technology giants. Even after last year’s shake-out, the so-called FAAMG stocks represent a fifth of the market’s total value. In Europe, too, the market has always been skewed to a small number of sectors and companies. What is interesting is how these have changed over time.

Roll back 20 years and European stock markets were dominated by cyclical value shares in sectors like banking, car manufacture, energy and basic resources. In the period between the end of the bubble and the financial crisis, these sectors accounted for a third of the value of European markets.

They are still important, representing just under a quarter of market value today, but they have just been overtaken by a group of shares that Goldman Sachs, never shy of a snappy marketing acronym, has branded the Granolas on the basis of their names. The 11 biggest European companies are: GSK, Roche, ASML, Nestle, Novartis, Novo Nordisk, L’Oréal, LVMH, AstraZeneca, SAP and Sanofi.

On the face of it very different from the likes of Apple, Amazon, Alphabet and the rest of the FAAMGs, these stocks are actually quite similar in some key regards - and very different from the cyclicals that used to characterise Europe’s investment opportunity. Like the tech giants, these companies all demonstrate: high and sustainable earnings growth, defensiveness in the face of economic uncertainty, high and stable margins, robust balance sheets and growing dividend streams.

They are a pretty good substitute for investors looking to diversify away from a set of market leaders that is starting to appear over-valued, over-regulated and over-bought in almost everyone’s investment portfolio. Accounting for 24% of Europe’s market value, the attractions of these reliable staples go a long way to explaining the outperformance of the region’s markets over the past half year.

Looking ahead, it is expected that these few companies will represent pretty much all the growth in earnings of the market as a whole. Over the next three years, sales are forecast to rise by 6% a year and earnings by 12% annually. For the rest of the Stoxx 600 index, both figures stand at 1% a year. How are they doing this? Partly because they invest more than their peers - 30% of total research and development spending. Partly because they buy well - half of all deals in the past five years have involved them. Partly, because they are so well diversified - only 20% of sales come from the domestic European market, with a third from North America, a third from Asia and the rest from emerging markets.

This strong growth underpins another key attraction of the Granolas - their ability to deliver a growing dividend stream. The 2.5% yield on average compares favourably with European bond yields and dividends have roughly doubled over the past 10 years. With dividend payments safely covered by earnings, that growth should continue.

Now, all this good news comes at a price. European shares as a whole are much cheaper than their US counterparts, but this group attracts a premium. They trade on around 21 times expected earnings, which is 60% higher than the market overall. But it is not unusual for shares with such a positive outlook.

With many investors adopting a global approach, the risk of being inadvertently over-exposed to the now less attractive US market is real. Even after the last six months of outperformance, Europe will get our vote this weekend.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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