Since the low point for the equity markets during the global financial crisis in 2009, Eurozone equities have lagged their US counterparts by an impressive 300%. Why is this? By the look of things, it’s a combination of different factors.
The first – and most important – reason is that US companies have performed much better than their European counterparts when it comes to corporate earnings. The graph below shows that since March 2009, the earnings per share of companies in the S&P 500 have increased 170%, compared with an increase in earnings of precisely 0% for companies in the Eurostoxx 50.
Some of this difference can be explained by share buybacks, but for the most part it can simply be put down to profitability.
The second reason is closely related to the first and concerns the index composition. Over the past ten years, the stock markets have been dominated by the emergence of several technology companies (Facebook, Amazon, Apple, Netflix, Google, Netflix, and so on) which are all located in the US. The technology sector accounts for the majority of the 170% earnings climb mentioned above, and has a weight of 26% in that same index.
This is compared to a weight of just 11% for the same sector in the Eurostoxx 50. These are also more traditional technology companies, and less so the internet and social media companies which have seen explosive growth.
The third reason is politics. Although Donald Trump’s triumph in the 2016 US presidential elections rocked the boat, his subsequent slashing of taxes went a long way to ease concerns. This stands in stark contrast with the endless list of political polemics in Europe. A debt crisis in southern Europe, which almost pushed Greece into the abyss; countries wanting to turn their back on the EU; the whole Brexit saga… And these are just a few examples. At a certain point investors will start to demand a political risk premium, which will drive down returns.
A question of valuation
And then there’s valuations. These go some way to explaining the huge difference between US and European equity returns. Since the financial crisis hit its lowest point in March 2009, US equities have become 2.1 times as expensive, European equities ‘just’ 1.8 times. Incidentally, while the effect of valuations shouldn’t be underestimated, it certainly isn’t the most important explanation for the difference between the performance of the S&P 500 and the Eurostoxx 50.
The last, less well-known reason for the difference in returns is the US 401(k) pension plan. This tax-free method of saving for retirement has also put pressure on US equity trade. Josh Brown from Ritholz Wealth Management points out that US 401(k) accounts have a total value just shy of USD 6 billion. What is important is that the monthly deposits have ‘simply’ continued during every period of market turbulence. The effect is Europe is much smaller.
Does this mean we should expect little from European equities in the coming years, too? Not necessarily. A cautious recovery of the world economy, preferably accompanied by declining tensions between the US and China, will mean better prospects for European equities. In addition, European equities are attractively valued relative to US ones.
This will work in Europe’s favor, certainly in the long term. In the short term, a Brexit deal, followed by a period of relative political stability, may help unlock some of this value. Let’s not forget, though, that we’re talking about Europe…