Even if you watch the markets as closely as I do, you can sometimes be surprised by what you see. My unexpected discovery this week, as the Nikkei 225 finally clawed its way back to where it stood 30 years ago, was the fact that the supposedly out-of-favour Japanese stock market has moved more or less in lock-step with the S&P 500 for the past 10 years. Both markets have nearly trebled over that period.
If you had invested $100 in the Tokyo market a decade ago, it would be worth around $280 today, just shy of the $290 that you would have achieved by investing on Wall Street. If you had put the same amount in the Chinese market in 2011 you would have $180 today, and you would have endured a much bumpier ride. Spreading your money around emerging markets would have delivered $130. Investing in the FTSE, unsurprisingly, would have been the worst decision. $100 in the FTSE 100 ten years ago is worth about $110 today.
The region I haven’t mentioned yet is the rest of Europe and yet this was the reason I printed off the chart from which I took these numbers. I realised that I didn’t really have a clue how European shares had performed over the past few years. Hardly anyone does. When did you last have a conversation about a European stock market? Which is curious when you consider that Europe is one of the richest corners of the world, home to many of the globe’s best companies and some of its most famous brands. Appropriately, then, Europe is hiding in the middle of the pack. Your $100 became $140 over the 10-year period, by the way. Yawn.
The reason why I’m getting interested in Europe now is precisely because no-one else seems to be. Asset allocation in recent years has been easy; even if the Japanese rally passed you by, you would have been happy just so long as you made sure you had enough in the US. Look at the fund managers who are pulling in all the money today and it’s simply because they have been on the right side of that trade. They used to say that no-one got fired for buying IBM. Well extend that to the whole US tech sector and the same holds true today.
But in a global reflationary recovery that may well not be the case going forward. I wouldn’t bet my house on the party being over for US growth shares but I’m certainly looking for ways to diversify my portfolio away from what’s been the market leader for a very long time now. And that leads me to the parts of the market for which no-one has any enthusiasm. And that, in turn, leads me to the huge, ignored market on our doorstep.
You don’t have to look far to see why Europe has lagged the rest of the world. At an aggregate level, its corporate earnings have been a disappointment. They stand just 2pc higher than they did at their pre-financial crisis peak. Over the same period, US earnings have risen by 87pc. At the overall market level investors’ preference for US shares has been wholly rational.
But the average is, in this case, misleading. Goldman Sachs recently recalculated European earnings growth as if the European market had the same sector composition as the US. That transformed the 2pc growth into 45pc over the period. In other words, European markets are just full of the wrong sorts of stocks. They are loaded up with banks and energy companies and don’t have enough of the whizzy tech stocks that have made America the place to be for investors.
The other thing to note about corporate earnings in Europe is that they are on the cusp of a dramatic recovery this year. Having fallen by 34pc in 2020, they are forecast to bounce back by 40pc this year and by a further 12pc in 2022 by when they will have regained their previous peaks in 2007 and 2018.
Apart from the expected earnings growth, what other reasons are there to think that Europe has been unfairly ignored by investors? Here are four.
The first is Europe’s sensitivity, like Japan’s, to the health of the global economy. It is a big exporter of the stuff that everyone will want during a post-pandemic recovery. It sells the capital goods that we will need as we start to build back better. And it dominates the luxury goods that everyone will covet once they are allowed out to spend again. Hermes said last week that travel-starved Chinese customers are snapping up its scarves. Its shares have risen 40pc in the past year.
Second, Europe is a leader in the green technologies of the future. Most leading wind power companies are headquartered in the region. Meeting net zero targets will require breath-taking amounts of investment in renewable energy and European companies will be some of the biggest beneficiaries. More generally, European companies are well out in front when it comes to the environmental, social and governance factors that investors rate so highly today.
Third, the sector composition that has been such a drag during the tech boom could look like a huge advantage as the rotation into more cyclical parts of the market is fuelled by rising bond yields in the months ahead.
And finally, Europe is cheap. Not madly so, but cheap enough to look interesting to global investors seeking to diversify away from a depreciating dollar and a pricey US market. European shares have not been cheaper compared with their US counterparts for nearly 20 years. Any further rise in the euro will be the icing on the cake for overseas investors. Maybe Europe will be this year’s surprise.
Tom Stevenson is an investment director at Fidelity International. The views are his own. He tweets at @tomstevenson63.
