European Renaissance? (Part 1)
Posted by: Brian Dennehy
The combined market values of Apple and Microsoft are now larger than that of the entire German stock market. Does this mean that these two companies are massively overvalued, or that the German stock market, and European stock markets generally, are massively undervalued? That is what I explore here. I want to see if you are missing a huge opportunity in Europe.
That statistic above is staggering. But it is not an isolated example of such extremes. Below is a chart showing that Apple alone has a greater value than Germany’s 30 biggest stock market-quoted businesses. This was from January, and the difference may now be slightly bigger still. What does this mean?
Apple itself is not hugely over-valued. It trades on a forward price/earnings ratio of 19. This is not cheap, but it would probably need to be 30+ to be regarded as in bubble territory.
So a not unreasonable working assumption is that Europe is notably undervalued versus the US. Digging a bit deeper, you can see that not only is this the case, but that we are moving closer to the point when there will be a huge sea-change – in favour of Europe.
Europe has been unloved for some time. Since March 2009 the US stock market has grown by 381%, compared to a paltry 133% by Europe (see chart 2 below). This is not because Europe itself is a basket case – though worries over the future of the EU have persisted, and I will return to that issue shortly. The European stock markets have a much heavier weighting to cyclical sectors – in an era of austerity that was an uncomfortable place to be invested.
In contrast, the US stock market has a greater tilt to technology, which, even with austerity, has enjoyed a much more reliable income stream.
It is the familiar Value vs Growth distinction,
which we have discussed a lot recently (see here
). “Value” sectors are more cyclical, “Growth” sectors, like technology, are much less cyclical and have steadier earnings from year to year. Predictably investors piled into the latter (now evidenced by a mania in the US stock markets) and side-stepped the former.
Even within Europe you can observe this divide. Since March 2009, the European Growth index is up 254%, and their Value index is up 130%, almost half.
What Is Changing?
The health response to the coronavirus, the economic response, and politics, are the catalysts for the change which lies ahead.
For sure no country has been perfect in its health response to the virus. But Europe does stand out for the progress it has made, whereas the US remains dysfunctional.
In the next week or so it will become clearer how the US will respond when several pandemic-inspired financial initiatives come to an end. As mentioned last week, they surely must continue with financial support of some kind, and Trump is likely to try and throw a lot of money at this before the November election.
The economic response in Europe is particularly interesting. The EU Summit which begins today will debate the Recovery Plan proposed by Merkel and Macron. This is not big enough to make a huge change to the immediate outlook, assuming it is voted through. But the precedent would totally change the longer-term outlook for the EU. Merkel, if not the German Constitutional Court, will have accepted that there must be EU-wide burden sharing. Remember, to this point the Northern European states (and their voters) have been very against bailing out the Club Med countries.
If that happens, fears over the break-up of the EU and/or eurozone would rapidly dissipate. Germany will have accepted that in a world which is de-globalising it must more actively help to re-energise Europe’s single market. There would be greater confidence in an EU-wide cyclical recovery, the sort that has been missing for a decade, hence the under-performance versus the US, and Value-sectors such as industrials being so poor.
More generally, the move away from austerity will be even more marked in the years ahead as the response to the coronavirus should speed-up sustained and large-scale stimulus in the post-virus years. Cyclical sectors (and whole stock markets with a Value-bias) will be huge beneficiaries of this change.
Last but not least, there is considerable political risk in the US (a Biden victory in November is nowhere close to being priced into their stock market), and Trump’s continuing insistence on irritating China will not help the US economy.
More To Come…
Next week, in part 2 we will look at the funds to exploit this sea-change. In next week's teleconference I will put some numbers on the extent of the outperformance you can expect by being more heavily invested in Europe versus the US – clue, it is considerable. And also in the teleconference I will update the outcome of the EU Summit which is underway today.