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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is chief market strategist for Europe, Middle East and Africa at JPMorgan Asset Management
Is this the beginning of a period of European exceptionalism in markets? Six months ago, most investors would have thought the idea absurd, even more so once Donald Trump was re-elected to the White House and on a mission to Make America Great Again. But in euro terms, the MSCI Europe index is up 9 per cent in the year to date compared with the S&P 500’s decline of 9 per cent. Investors are questioning whether the tide is turning. It may well be.
Europe’s decade of equity market underperformance was caused by relative macroeconomic weakness, and the “wrong” sectoral composition. Let’s take these in turn. Naysayers will argue Europe’s economic problems are structural. Demographics aren’t conducive to strong growth and Mario Draghi, in his paper on Europe’s competitiveness, did a super job of highlighting the problems that come from the continent’s fragmentation.
However, there is another part of the region’s underperformance that is often overlooked. That is, for the past decade, Europe has been kept on a very tight rein in all aspects of policy — fiscal, monetary and regulatory.
Here are some statistics to demonstrate this point. In the past decade, the US government has been showering its economy with cash: subsidies and tax cuts for companies and, quite literally, cheques in the post for households. As a result, government debt as a per cent of GDP has risen by 17 percentage points. By contrast, in the eurozone, government debt as a per cent of GDP has fallen by 5 points.
Monetary policy also played a critical part in the relatively weak period post-pandemic. Though the Federal Reserve also raised interest rates to combat inflation, the impact on US households and businesses was limited by the fact that the vast majority of mortgage borrowers were protected by long-term contracts, locked in at low interest rates. By contrast, Europe’s borrowers still largely rely on floating rate interest rate loans provided by their local bank. Statistical measures that capture these financial conditions show barely any restrictiveness in the US, but in the Eurozone and UK, financial conditions have been tighter in the past two years than at any point in the past 15 years.
Finally, one also has to consider regulatory policy. Regulations to combat climate change have soared in recent years to drive companies towards broader net zero targets. Adding to these macroeconomic woes, Europe’s stock markets were short of the tech stocks that were much in favour, as artificial intelligence excitement grew, and overweight in the financial stocks.
Viewed through this lens, one can see how the tide is turning. The adversarial stance of Trump has galvanised the region into action. Fiscal policy is being loosened, and not only in the area of defence. Germany’s €500bn infrastructure package alone is a boost of 1 per cent of the country’s GDP annually over the next decade. Monetary policy is also easing. It looks likely that real interest rates will soon be back close to zero in the Eurozone and the UK. This is already spurring loan growth. And, finally, regulatory stipulations are easing in areas such as climate change policy.
While all this should boost confidence and fuel the recovery, it could be offset by a wave of US tariffs and a worsening situation in Ukraine. But one also has to overlay this macro view with an assessment of the outlook for key equity sectors, particularly US technology. The last significant period of European equity outperformance, relative to the US, was 2000-09, coinciding with the long and painful bursting of the US tech bubble in the 2000s.
It is not obvious that US tech stocks are destined for the same fate this time around. The companies that have driven US returns in recent years have been producing fantastic earnings, and most have considerable cash on their balance sheets. But these companies are at that tricky stage of having to live up to the AI hype and deliver a high return on the massive amounts of investment they have been deploying.
Despite recent relative performance, most European stocks still trade at a heavy discount to their US counterparts. The points I’ve made above therefore do not, to me, appear to be in the price yet. Investors that have focused on passive investing should be particularly wary, given the weight of the US in the global MSCI ACWI benchmark has increased from 42 per cent in 2009 to 66 per cent today. This recent European outperformance might not be over, and investors should continue to think about whether such a large overweight to US equities is the right set-up for the decade ahead.
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