Why Europe Can Outpace the US

After the election victory of Emmanuel Macron in France, Europe’s stock markets are becoming attractive for investors again. For them, the continent also has a key advantage with respect to the U.S.

What a difference. Jan. 20: Donald Trump continues his populist tirades in his speech upon taking office, characterized by “America First” and by confrontation with his opponents. May 7: Emmanuel Macron appears before his populace with the European National Anthem and reaches out to those who voted against him. Two scenes that couldn’t have been more opposite, but that also symbolically stand for where Europe and the U.S. are headed.

And now consequentially, investors are also increasingly taking action accordingly. Up to now, Europe’s financial markets have been greatly unpopular for them: The continent seemed to wander from crisis to crisis, the economy was stagnating in many places, and corporate earnings—the most important criterion for stock investors—remained far behind those of U.S. competitors. But exactly that is now changing, boosted by the election victory of Macron in France. “European stocks are – thanks to France – a good choice again,” said Björn Jesch, chief investment officer at Union Investment.

This trend could already be observed last week. Roughly since March, since the election in the Netherlands in which the right-leaning populists performed weaker than feared, the Eurostoxx-50 Index has progressed better than its American counterpart, the S&P 500. This trend once again visibly intensified after the first round of the French presidential election, when it was shown that Emmanuel Macron would make the race.

The reason for this is that political risks up to now have been hanging over the future of the European Union like the sword of Damocles. That meant international investors have shied away from investing their money there. Now this fear has dissipated, and at the same time, investors are becoming more careful with regard to the U.S. “The markets are hesitating at the moment because they have doubts about whether the Trump government can in fact implement the promised reforms,” said Philippe Uzan, chief investment officer at Edmond de Rothschild Asset Management. “We see this phase as a true opportunity for the eurozone to flourish.”

Weaker Profit Dynamics in the US

At the same time, a reversal in political risks indicates a change of trend in corporate profits. That is at least as important for investors, because in this regard, European corporate deficit has recently been glaring. “The disparity of profitability was never before so great as in past years,” said Timo Schwietering of Metzler Private Banking.

He also analyzed what caused this. According to this analysis, one-fifth of the deficit traces back to larger operating margins of U. S. corporations. However, a further sixth is explained by U.S. corporations massively buying back their own stocks. As a result, the number of their stocks was reduced and in turn, the profit of each stock rose purely visually.

This was possibly due to low interest rates. Many U.S. firms took on cheap credit and used the money for such financial cosmetics. If one counts together the dividends and stock buybacks that also ultimately benefit shareholders, then many American corporations have paid out even more than they earned in recent years. “But now that the interest rate environment is turning, this will change,” said Schwietering. Thus, the profit dynamics in the U.S. will weaken.

At the same time, they are increasing on this side of the continent. “This year marks a turning point in Europe,” said Britta Weidenbach, responsible for European stocks at German Asset Management. “Profit growth has returned after six weak years, we are figuring on a double digit plus in annual comparison.” The data up to now corroborate this, because in past years, the profit prognoses were always revised downward around this time; this time it is the opposite.

“That’s the big story in the markets.”

All this comes down to the fact that the European markets are rated substantially better than the American ones. Therefore, Jochen Stanzel of CMC Markets is figuring on a stream of capital from U.S. markets to Europe in the coming weeks. “That’s the big story in the markets that, however, will not be expressed right away today, but rather could be expressed in constantly further rising prices if global funds gradually enter Euro stocks.”

Ultimately, this trend could support a rising euro rate as well, because with that, the profits of non-European investors would rise additionally. And there are indications for such a trend: The euro is presently quoted at the highest level since the beginning of the year, jumping over the $1.10 mark overnight into Monday even in Asia.

That is due, on the one hand, to the positive news from Europe; on the other hand, to an increasingly bad atmosphere in the U.S. “In the U.S., the impression is emerging that the dollar is currently being propped up by the Fed alone,” said Wolfgang Kiener, currency expert at the Bavarian Landesbank. “The implementation of the plan for lowering corporate taxes, important for the dollar, appears to be moving far into the future; Trump’s announcements on this are hardly being taken seriously by the markets.”

France Will Now Have to Deliver

The latter is also due to the fact that the border adjustment tax originally envisioned by the Republicans which would have the effect of a type of tax on imported goods and which is supposed to offset the massive reduction in corporate taxes does not appear in Trump’s official tax plan. “And considerable infrastructure expenditures are currently not foreseeable at all.”

Europe could now have a great chance at making use of positive momentum and come out ahead economically as well as in the stock markets and outpace the U.S. However, in order for this to succeed, the EU cannot become involved in new conflicts and crises. “The performance of the financial markets will also depend on whether reforms are actually carried through in France,” cites Phillipe Uzan as an important point. The clock is ticking as of now.

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About Sandra Alexander 456 Articles
I have retired after41 years of teaching German in the Philadelphia area - 33 years at a high school and 8 years at a small, private college. I have an M.A. in German and keep my German language skills current by translating.

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