Europe's healthy "Granolas" stocks

Followers of global stock markets love nothing better than a nickname. Today investors are transfixed by the Magnificent Seven (or Mag7): the seven US-listed technology stocks known for posting outsize performance and driving the market higher. But as performance begins to diverge in this tight-knit group, investors are turning to a new set of stock market darlings: the Granolas.

Nothing to do with breakfast cereal, despite the name, these are the 11 pharma, tech, and luxury stocks that as a group have delivered an average 15 per cent gain over the past year, and contributed some 60 per cent to the European STOXX 600 indexs overall growth. Now making up 25 per cent of the STOXX 600, the Granolas are approaching the dominance of the Mag7, which represent 28 per cent of the S&P 500 by market capitalisation.

Global giants

The Granola nickname derives from the first letters (sort of) of the 11: GSK, Roche, ASML, Nestle, Novartis, Novo Nordisk, L'Oreal, LVMH, AstraZeneca, SAP, and Sanofi. The group is largely consumer-oriented, with a bit of tech thrown in for flavour. They are listed on equity markets across Europe, but are all international businesses with exposure to global economic forces.

While all equity investments involve a higher level of risk than, say, bonds, "the Granolas are a far more heterogeneous group than the Mag7," explains Chris Burger, Senior Equity Analyst at LGT Private Banking. 

"The European rally is therefore broader than the tech rally in the US. That diversification makes for a broader though not perfect representation of the market." Concentration risk is an oft-cited problem with the Mag7, but Burger suggests this is not an area of major concern with the Granolas.

Relatively defensive

With pharmaceuticals, consumer staples, consumer discretionary, and technology represented, sectors that account for over half the market capitalisation of the STOXX 600, the Granolas offer an interesting positioning in today's rather complicated market. "The group is relatively defensive, with eight of the 11 in consumer staples and pharma," continues Burger. "This means that some of them can be described as bond proxies, which are stocks in established companies that pay regular dividends and are less volatile than the market." However, no investment in stocks is without some risk of loss.

That said, not all of these stocks perform stolidly. Some soar. Novo Nordisk, with its weight loss and diabetes drugs, is the star performer in the group, posting a 70 per cent stock price rise in the past 12 months. The other pharmas in the group have also benefitted from corporate earnings growth and rising profit margin performance.

The conclusion: the Granolas may offer both stability and opportunity. "LMVH in the consumer discretionary sector, and SAP and ASML in tech represent a bit more spice in a portfolio," Burger says. Compared to the Mag7, the Granolas overall have offered lower stock-performance volatility and higher yields in the past. 

Granolas dwarfed by Mag7

However, measured by the size of their total market cap, the Mag7 are far bigger than the Granolas. The Americans have a combined market cap of USD 13 trillion, while the European group's cap is only USD 3 trillion.

Does size matter? Burger explains that "size is generally an advantage, but the Granolas have outperformed over time due to their strong management teams." Nevertheless, there is no guarantee that these management teams will stay in place, so past performance is no guarantee of future outperformance.

Recent history suggests that until the dominance of groups like the Mag7 and the Granolas, smaller cap stocks outperformed large caps. "Smaller caps are riskier by definition, so performance needs to be balanced by assessments of risk," Burger notes.

When interest rates are high and geopolitical risks rising, defensive stocks generally draw in investors. And in the current high interest-rate environment, smaller companies are disadvantaged. Financial institutions lean towards lending to larger, less cyclical businesses that offer long-term stability. Slower economic growth will also continue to bias investors against smaller, lower-quality companies.

Passive versus active

Another trend, of course, is the apparently inexorable rise of passive investing. The increase in market concentration seen in the STOXX 600 and S&P 500 is evidence of the money flooding into passive, index-tracking funds, which usually invest in all the stocks in a given index. 

"The problem is that now, because of the rise in market cap of companies like the Granolas, the index is relatively expensive," contends Burger. "This provides active investors with new opportunities."