Is it time to buy Europe and sell the US?
Europe is looking ever more attractive to investors, while the US is starting to look like the riskier bet, says John Stepek.
Earlier this week, the European Union managed to agree a deal to issue joint debt to fund a post-coronavirus recovery package.
The deal wasn’t perfect or even especially impressive. But it was a deal.
Does it make European stocks worth betting on? Not in itself.
But something else does...
The US dollar looks like it’s heading lower for longer
The US dollar is one of the most important prices in the world.
Everyone needs dollars. So when US dollars are expensive, it means that money is tight across the globe.
US dollars have been expensive in recent years. That seems to be changing now.
The US dollar index (a measure of the dollar compared to the currencies of its biggest trading partners) has been slipping steadily in recent weeks and this week it’s taken a tumble. Meanwhile, the euro has been creeping higher.
What’s going on? Partly it’s the fact that Europe appears to be past the worst of the Covid-19 outbreak (obviously it could come back, but we’re talking as things stand), whereas the US still appears to be struggling.
Perhaps more significant is the collapse in US interest rates. Markets finally believe that the Federal Reserve has no intention of ever raising rates again until inflation is properly ignited. That would mean throwing the dollar to the wolves.
Remove a big chunk of the break-up discount from the euro (which is what this week’s agreement on a recovery fund has confirmed), and suddenly it looks it might be the more solid alternative currency bet.
I’m not suggesting that you start trading currencies – that’s a swift road to a high blood pressure count and a low bank balance.
But given the valuation gap between European and US stocks, now might be the time for Europe to play catch up and outperform the US. Indeed, European markets have been outperforming the US for a couple of months now.
I could point to lots of different bits of data, but here’s one very illustrative statistic for you. As Eoin Treacy of the excellent FullerTreacyMoney service points out, the combined value of all the shares on the tech-heavy US Nasdaq index "is now greater than the GDP of the whole European Union.”
It doesn’t mean the US market is going to hit a top any time soon. But it’s just yet another indicator of how expensive it is.
Will the US market start to worry about the November election?
Another event that might make Europe look more attractive is the US presidential election.
I can’t claim to be Donald Trump’s biggest fan. I wouldn’t shed any tears if he has to leave office after the vote in a few months from now.
However, I’m very intrigued by the market’s reaction to a Joe Biden presidency. What intrigues me is the apparent lack of reaction so far.
Betting markets (which are not infallible but are pretty reliable) reckon that Democrats will win both the Senate and the House. That means Biden should be able to push through his agenda. And one of the key things that he’s planning to do is to reverse the Trump tax cuts. So corporation tax will go back up, as will income tax.
Whether you agree with that or not, it’s not what you’d typically view as a market-friendly prospect. So why hasn’t the market reacted yet?
There are some good reasons. A Democrat majority might raise taxes back to where they were, but they’re also even more likely than Trump to spend a lot of money both on direct stimulus and on infrastructure and on getting people back to work.
Maybe a less abrasive president might improve relations with various global allies or even make relations with China a little less fraught (although don’t bet on it – I think that’s all too far gone).
Maybe after the lacklustre US response to the coronavirus they feel that it’s time for a change. And maybe – given a backdrop of rampant money printing – markets don’t really care who ends up being in charge at this point.
So it’s possible that markets are able to look beyond the tax rises and simply think that a Biden presidency would be the best outcome. And as I always say, politics is local – so maybe I just don’t know what I'm talking about, just like all the US commentators with weird misconceptions about what Brexit means.
That said, given what markets are like, it’s also possible that investors just haven’t quite mentally adjusted to the idea yet. So far, my sense is that Biden is in a “stealth” bull market. Investors may simply just be assuming that Trump will somehow retain the presidency come November.
So there’s the potential of a wake-up call – maybe an unnerving one – closer to the big day. And obviously there’s also the concern that the election won’t be cut and dried. Imagine repeating all that debate about “hanging chads”, only this time with Trump in the White House. Not fun.
Anyway – maybe the election will have no impact at all on the market, but I’m just raising it as another potential trigger for outperformance in Europe.
Plenty of you will have exposure to the eurozone already. But if you’re feeling particularly bold, John Authers notes in his Bloomberg newsletter that, according to Absolute Strategy Research, the “peripheral” countries tend to be the best catch-up plays.
In other words, when Europe is beating the US, the riskier European countries tend to beat the more traditionally investment-worthy European countries. So if you fancy a walk on the wild side, it might be time to break out your Italian and Greek ETFs again.
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