With all eyes focused on the US election, no-one is very interested in what’s happening in Europe.
The flurry of activity over stimulus plans has ebbed and European stock markets have been unexciting. However, Europe may be a key beneficiary of a growing disillusionment with US equities.
The fate of Eurozone equities lies as much with the fortunes of the US as it does with its own. The US has been the go-to stock market at a time when lower interest rates and quantitative easing have left investors hunting for growth stocks.
This choice has been supported by a strong dollar, which has help inflate investor returns.
This has sucked fund flows away from European markets, where investors have to hunt harder to find high growth technology stocks. JP Morgan Asset Management estimates that as much as €240bn has come out of European-focused mutual funds and ETFs over the last 30 months.
However, there are signs that the lustre of the US stock market is starting to fade. The Nasdaq has wobbled since the start of September as investors have fretted over sky-high valuations for the major global technology stocks.
It always comes down to politics
There are other pressures in the US.
The dollar has been declining in response to political instability – a potentially disputed election, a fractious populace and a ‘bad’ pandemic.
Equally, there are concerns that if the Democrats win both the Presidency and the Senate, this could be bad for the technology companies that make up around one-third of the S&P 500. It has been assumed that Joe Biden may look to disrupt the dominance of the technology companies.
This is causing US stocks to wobble after a long run of strength.
The question is whether Europe will be a beneficiary.
Morningstar data shows that technology funds have seen significantly less demand in the past two months, while UBS reports that money has tentatively been moving into European markets from US since May.
This may build momentum as investors start to lose faith in the dollar and US assets.
Europe is cheap
Rajesh Tanna, head of the JP Morgan Asset Management International Equity Group, says European equities also stack up on their own merits. Particularly important is the changing nature of the European market:
“The Eurostoxx 50 had 50-60% focused on financials, energy and telecoms. If you look now, 50-60% of the market is focused on consumer, healthcare and technology. That’s important for two reasons: first, the quality of index is much better than perception.
“Also, one of the reasons Europe underperformed in the last cycle is because of a lack of profit growth. When you have those low-growth industries leading the charge, it makes sense that you see no profit growth. If we think about the next cycle, having consumer, healthcare and technology companies leading the charge, there is a better chance of Europe showing profit growth and delivering outperformance versus other areas.”
Equally, most asset allocators, whether they like Europe or not, will agree that it is cheap.
Gavin Haynes, a consultant at Fairview Investing, says: “There is no doubt on a like for like basis that European companies are trading at a discount to those in the US.”
In common with other countries, Europe is seeing a polarisation between expensive growth stocks and cheap value stocks, but the expensive growth stocks are far cheaper. The dividend yield is also attractive at around 3%. This is near the region’s long-term average and a meaningful uplift over the region’s bond yields, which are negative in many cases.
But Europe still has its naysayers
James Calder, research director at City Asset Management, says: “The problem with Europe is that there tends to be something waiting in the winds. Are there political problems that will resurface once Brexit has been negotiated?
“It is good to see moves towards fiscal union, but we are retaining a modest underweight position because it is hard to see the catalyst for a significant turnaround.”
Tanna believes the catalyst may be monetary stimulus: “The Eurozone is breaking taboos – until recently who would have thought about bond issuance at Eurozone level? We are no longer hearing about the Eurozone break up. The crisis has impacted everyone, but the European leadership’s approach has brought the union together and it is ahead of the curve. It has lessened political risk in the region.”
If anything, political risk now looks considerably lower than in the US.
He also suggests that Europe could be the key beneficiary from an improvement in global growth. With the world still in the depth of the pandemic, a resurgence in growth still seems some way off, but given fiscal stimulus packages, it remains likely should a vaccine be found.
Tanna points to luxury goods companies, for example, that may be beneficiaries of improving consumption in China or semiconductor companies that supply Apple and could be ‘the new oil’.
There are also areas where Europe can genuinely claim to lead the world, such as renewable energy. The EU and governments across Europe have made this a priority as they build back the region’s economies. The EU plans to mobilise around EUR1 trillion in sustainable investment over the next decade, as part of its Green Deal.
Of course, there are still problems. The services sector is still lagging in the wake of the Covid-19 crisis even if manufacturing has recovered.
Some countries – Italy, Spain – are likely to have significant budget holes to fit as they emerge from the crisis, which may yet prove destabilising. However, Europe has been unloved for some time and it may yet be its moment.