Author: David Flynn, Chief Investment Strategist and Director.
Earlier in the year we rebalanced the Equity portion of our portfolios away from US equities on the basis that the US was very expensive vs Europe and the rest of the world. Here is an excerpt from a note that we wrote to clients at the time (In italics).
“Fidelity Euro 50 Index Fund (a low cost fund which tracks the Euro Stoxx 50): We like adding European exposure to the portfolio for a few reasons. Interest rates have come down since late from 4% in 2023 to 2.75% in January. Interest rate cuts are stimulative to the economy and also lower yields on cash incentivize people to look for alternatives where yields can be more attractive. This ETF trades at 15X earnings. This is a bargain relative to the US which trades at 23X earnings. This is the widest valuation gap in history!
The US is not just expensive vs Europe, it is also very expensive vs the rest of the world. US stocks now trade at 22X forward earnings estimates vs 14X for the rest of the World.
To make things even more extreme, the US market now makes up 70% of the world index, yet it only represents 26% of global GDP, and the 7 largest stocks in the US, known as the ‘Magnificent 7’ or ‘Mag 7’, now make up 39% of the US market.
This rising concentration risk in the US has driven a lot of traders and managers to be severely underweight the rest of the world, relative to the US and they are particularly underweight Europe, probably because of sentiment relating to the war in the Ukraine. We are more drawn to Europe for that reason. A move from underweight to a more equal weight stance would be a strong catalyst for much higher prices.
Markets price in what they know, discount those things and look forward, not backward. There is a lot of negativity priced into Europe, which means the hurdle for positive surprises is pretty low. What could cause it? I don’t know. I don’t have a crystal ball, a peace deal in the Ukraine would probably do it, but it could be a lot of things. All I know is that a lot of negativity has already been discounted by the price, which sets a low hurdle for positive surprises.”
Equity index return numbers noted below are all based in Euro denominated terms as of June 9. Data is taken from unhedged (currency) European UCITs ETFs, which include costs as well as dividend payments.
US S&P 500: – 6.6%
US NASDAQ 100: – 5.5%
Euro Stoxx 50: 13.5%
MSCI Europe: 11.4%
FTSE 100: 8.5%
MSCI Japan: 0.8%
MSCI World: – 3.1%
MSCI China: 7.1%
MSCI Asia Pacific ex-Japan: 3.4%
MSCI Emerging Markets: 2.6%
As you can see, US Equities have dramatically underperformed the rest of the world, regardless of which region you are comparing them to, but especially Europe where you can see, depending on which US/Europe index you are comparing, an 18-20% difference in returns.
It is ironic, but it turns out that Trump has been good for European Equities. Let’s look at the drivers.
- The Euro is up 10.5% vs the Dollar this year. Remember that the Dollar is still the reserve currency of the world. A large majority of global trade happens in Dollars. This is a 10%+ jump in purchasing power, which helps to alleviate inflation pressures in Europe.
- Crude Oil is down 10% this year, and European Natural Gas is down 28.5% this year, no doubt helped along by Trump’s “Drill Baby, Drill” policies. This dramatically helps profit margins in Europe (and other parts of the world) and also helps to bring energy costs dramatically lower for households/drivers.
- Trump’s move away from supporting NATO has caused Europe to dramatically increase fiscal spending (€1 Trillion annually) in relation to Defense. Remember when government’s borrow, it creates a liability on the government balance sheet, but it also becomes the economy’s credit.
So is Europe’s outperformance of US Equities over? From a longer term perspective, we believe that it has only just begun;
The chart above shows the Dollar denominated Eurostoxx 50 ETF divided by the S&P 500 ETF. When it is rising, European Equities are outperforming US Equities and when it is falling, US Equities are outperforming European Equities. As Julian Brigden has noted with his chart, we’ve seen a major trend line break to the upside in this ratio, for the first time in 17 years.
I’ll leave you with one last cherry on top. Europe is experiencing all-time record low levels of unemployment!
Kind Regards,
David Flynn
Chief Investment Strategist, Director & Partner
For more information or to find out how to invest Email pbrown@baggot.ie
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