By Mike Dolan
LONDON (Reuters) – A year ago, investment circles were on fire for a leap east across the Atlantic. But that stock market trade has yet to bear fruit, undermining the advice to do so one more time this year.
In the mid-summer of 2020, many investors began switching to cheaper European stocks from seemingly overvalued US indices highly concentrated on tech companies making blocking windfalls.
The rotation seemed to make sense as the post-pandemic recovery expanded and the US elections loomed.
And yet new waves of COVID-19 during the northern winter and November’s clean sweep for money-spending US Democrats tarnished the performance of this trade ever since.
To be fair, the Eurozone’s main benchmark index kept pace with Wall Street, both gaining about 38% in dollar terms since June 30 last year.
But other measures are less flattering. Britain lagged behind both by 10 percentage points, with UK stocks a drag on Europe as a whole. The US small cap made 62% gains while staying ahead of the majority with a 43% jump.
A year later, emboldened by vaccination and the strengthening of economic output and earnings growth, the case for the eastern side of the pond and its more cyclical companies and cheaper “value stocks” is getting once again.
Goldman Sachs (NYSE 🙂 notes that mutual fund flows into European equities this year have been the strongest since 2015.
But entries to all equity markets are increasing everywhere, and the relative picture is much less clear.
The main problem, according to Goldman, is not Europe’s attraction to foreigners. European equities held by US investors have almost tripled to 28% in 20 years and foreign investors generally hold 43%.
The big problem is closer to home. Due to regulatory and demographic factors and increased risk aversion, European funds and households remain laden with bonds and cash, and pension and insurance funds own only 3% of European stocks.
Much of that will not change overnight.
A strong European recovery, which saw euro zone economic sentiment rise to its highest reading in 21 years in June, could help.
What’s more, latent fears of a hit to US high-tech indices from global minimum tax deals and increased antitrust pushbacks against “big tech” speak loudly of some rebalancing.
But even here echoes of 2020 can be detected. Fears that new COVID variants threaten another European summer tourist season are a reminder against betting on a premature end to the pandemic and increased political risk in the third quarter. it probably resides in the German federal elections in September.
The resurgence of the dollar’s strength against the euro, as the Federal Reserve leans towards the hard line while Europe’s central banks deliberately do not, is another warning shot.
But those who are willing to step back a bit in the news flow can still be rewarded.
Long-term strategists at JPMorgan (NYSE :), Jan Loeys and Shiny Kundu, doubt that there is endless outperformance in America.
“History warns against eternal bull markets,” they wrote, arguing the case for a strategic underweight to US equities and showing evidence of a mean reversal in 10-year US relative returns versus the rest of the world over decades, coming from bows in earnings, the dollar and technology sector.
His conclusion is that people are probably too overloaded in US stocks right now and see a good case for having at least a little less US stocks than their massive 58% weighting in MSCI’s all-country index. By comparison, the US economy itself is only a quarter of the world’s economic output.
That high MSCI weighting follows relentless outperformance for more than a decade since the 2008 bank crash, as borrowing costs were kept low and the digital revolution accelerated across US-based tech companies. But essentially global.
Any diversification gains for investors from being elsewhere were more than offset by better returns from US stocks.
But tracing the sample back 50 years, JPM research showed that 75% of the top or bottom profitability of the 10 consecutive years in the US was reversed in the following decade.
With equity valuations in non-US markets relative to US stocks at a record low, a reduction in US weights in global portfolios to around 50% may be justified, Loeys and Kundu wrote. And the rest would better carry over to other developed stocks rather than emerging markets now clouded by waning potential growth rates.
With Europe accounting for just 17% of the index for all MSCI countries, the mean reversion argument points there.
And yet many are wary of how “cheap” Europe is, wondering if it can make up for the slack, pointing to relatively low profitability and margins in European companies compared to US companies and a glaring absence of a sector. technological equivalent.
Stephen Jen of hedge fund Eurizon SLJ acknowledges that he does not see clear fundamentals why European profit margins would increase from here. Furthermore, demographics, where Europe’s profile is only about 20 years behind Japan’s, would continue to see euro zone savers recycle the bloc’s current account surpluses abroad, just as Japan has done for decades. .
“The current market fixation on the likely speed of the economic rebound in the coming months seems out of place,” he said. “The debate should focus on what could happen beyond the cyclical rebound that virtually all economies are experiencing sooner or later.”
(By Mike Dolan, Twitter: @reutersMikeD. Graphics by Thyagu Adinarayan; Edited by Lisa Shumaker)