Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Exactly a week after the summer solstice last year (all my investment views are inspired by the heavens) I wrote in this column that “ . . . a new asset class is jiggling my contrarian bones: European equities”.
In June, populists had surprised in Europe’s parliamentary elections. Then President Macron called a poll which pitted Marine Le Pen’s far-right against the leftwing Nouveau Front Populaire.
Investors found the choice as appealing as cold ham or cheese slices for breakfast. Bleurgh! European credit spreads spasmed, bond yields rose, and French stocks dropped 7 per cent.
The mood was already pretty negative back then. Low economic growth. Industry-killing Chinese electric cars. Only three European names in the MSCI World’s top 30 companies. Little tech. Over-regulation.
What a difference eight months can make! Since I wrote that column, the Stoxx Europe 600 index is up 9 per cent — about 150 basis points ahead of the S&P 500 as well as the broader world benchmarks.
Much of the gains have come since Donald Trump’s inauguration. The irony! Despite his pro-growth, America-first rhetoric, US shares now trail European ones by more than 10 per cent since January 1.
Everyone tells me the reasons are obvious (unlike six months ago, obviously). Trump is forcing the continent to re-arm. Germany is fiscally loosening. A nascent Chinese recovery is good for European exports.
What do I think of this U-turn in sentiment? It has added some variety for sure. The emails saying I’m an idiot for not owning US equities have been replaced by emails saying I’m an idiot for not owning European ones.
It’s a fair cop. Europe constitutes a larger slice of the global economy than the US and has double the population. Sure its combined equity markets are 60 per cent smaller than the S&P 500 — but owning none is a big call.
I’m not as stupid as I look, though (just as well, I hear you mumble). When I pondered a European ETF last year, my main reason for doing so was value — both compared with history and other markets.
Indeed, in my view, this leap in European shares is simply a closing of a valuation gap that had widened too much. Investors always blame something else when markets normalise.
Falling property values didn’t pop Japan’s bubble. Bubbles always pop. Nor was the dot.com collapse due to insane business models. It was exuberance gone mad with stock prices to match.
Hence every portfolio manager is now blaming tariffs or Trumpian uncertainty for the drop in US equities. How could we have known? Sorry, but those sky-high valuations you were happy with left no room for even a hiccup.
Likewise, who could have guessed that chancellor-elect Friedrich Merz would conjure up €500bn of debt-funded infrastructure spending, exempt defence from borrowing rules, and allow states to splurge?
No-one. But valuations suggested Europe would never recover. And that nothing would ever come along to challenge the US’s pricing-for-perfection versus the opposite for Europe. You believed this at your peril.
Markets will always find a news story as an excuse to rally when they are cheap and vice versa. So the question is: why didn’t I add some European fuel to my portfolio in June and wait around for the inevitable spark?
For two reasons. First, my issue wasn’t a lack of attractive companies in France, Germany, Italy, Denmark and Holland. There were plenty. It was that my other funds were still undervalued (in my opinion) too.
Not by as much, it is true. By midway through last year, Asia, UK and Japanese equity markets had done very nicely. I could have top sliced all three by 5 per cent I suppose and put that cash in Europe.
It wasn’t just laziness, the beginning of summer, and trying to learn how to wing foil that stopped me. Honest. The second reason I resisted was I also knew that if equities on the continent were to fly, so would my UK ones.
That’s partly because many European funds include British companies. Do you know if yours does? Europe. Eurozone. Pan-Europe. EMU. Core Euro Stoxx. MSCI Europe. FTSE Europe. The labels are confusing.
I also figured that if excitement grew over the Channel, it would here too. Europe still accounts for almost half of UK exports. If Paris and Berlin felt the need to re-arm, so would Britain, with its hefty number of defence stocks.
And so it has turned out. Since my column last June the FTSE 100 index has almost mirrored the rise in European shares. And whereas the S&P 500 is down this year, my UK fund is up about 6 per cent.
What about from here, though? Does a seismic change in Europe brought on by Trump — in particular the biggest shift in German economic policy since reunification — mean we should all leap in?
I’m not so sure. Certainly bondholders aren’t. Yields on 10-year Bunds are skyrocketing at the moment as prices collapse. The 30 basis point jump on Wednesday was the most in a day since the fall of the Berlin Wall.
Of course, Bund yields in absolute terms are low — still less than 3 per cent — thanks to decades of Germans being uber-conservative with borrowing. But it worries me that the sell-off seems to be spreading internationally.
In a world rife with countries with too much debt relative to GDP, it was always comforting that Berlin understood the value of fiscal prudence. If it has capitulated — what hope is there? Splurge away!
This maybe explains the nervousness in equities right now. Personally, while I reckon Europe’s discount to the US has more to close, its companies in aggregate will never deserve valuation parity, let alone a premium.
But maybe some individual sectors and stocks are worth a look? More on this in my next column.
The author is a former portfolio manager. Email: stuart.kirk@ft.com; X: @stuartkirk__
