6 Minutes Read (The author is Reuters News’ finance and markets editor-at-large.) Any opinions he expresses are his own.) (Reuters) – LONDON, June 30 (Reuters) – A year ago, there was a lot of chatter in the financial community about taking a jump eastward across the Atlantic. However, that stock market trade has yet to pay off, casting doubt on instructions to do it again this year. Many investors began switching to cheaper European equity in mid-summer 2020, from what appeared to be expensive U.S. indices heavily focused on tech firms reaping enormous windfalls. As the post-pandemic recovery widened and the US election loomed, the rotation seemed to make sense. Nonetheless, additional waves of COVID-19 through the Northern winter and November’s clean sweep for high-spending US Democrats have blemished the trade’s performance ever since. To be fair, the euro zone’s main index kept pace with the S&P500 on Wall Street, rising roughly 38% in dollar terms since June 30 of last year. Other metrics, on the other hand, are less favourable. The FTSE100 in the United Kingdom trailed both by ten percentage points, with UK stocks dragging down the STOXX 600 in Europe. The Russell 2000, a small-cap index in the United States, led the way with gains of 62 percent, while the Nasdaq 100 outperformed the rest with a gain of 43 percent. A year later, the case for the eastern side of the pond and its more cyclical firms and cheaper “value stocks” is being made once more, bolstered by immunization and stronger economic output and earnings growth. According to Goldman Sachs, mutual fund flows into European stocks have been at their highest level since 2015. However, inflows to all equity markets are surging, making the relative picture less apparent. According to Goldman, the main issue is not Europe’s appeal to foreigners. Over the last two decades, the percentage of European equity held by US investors has nearly tripled to 28%, with foreign investors holding 43%. The major issue is much closer to home. Because of regulatory and demographic constraints, as well as increased risk aversion, Europe’s funds and households remain heavily invested in bonds and cash, with pension and insurance funds owning only 3% of European equities. Much of this will take time to change. A strong European rebound, which saw euro zone economic morale reach its best level in 21 years in June, could help. Furthermore, mounting antitrust pushbacks against “Big Tech” and simmering fears of a hit to tech-heavy U.S. indexes from global minimum tax agreements point to some rebalancing. However, there are echoes of 2020 even here. Fears of new COVID varieties threatening another European summer tourist season serve as a reminder not to bet on a quick conclusion to the pandemic, and the most significant political risk in the third quarter is likely to be the German federal elections in September. Another warning shot across the bows is the re-emergence of dollar strength against the euro, as the Federal Reserve leans hawkish and Europe’s central banks expressly do not. Those who are willing to step back from the news flow, however, may be rewarded. Jan Loeys and Shiny Kundu, long-term strategists at JPMorgan, are skeptical of the rationale for further US outperformance. “History warns against endless bull markets,” they said, arguing for strategically underweighting U.S. stocks and demonstrating mean reversion in relative 10-year U.S. returns vs the rest of the globe across decades, citing revisions in profits, the dollar, and the tech sector as proof. Their conclusion is that consumers are probably just too overexposed to American stock at the moment, and that there is a reasonable justification for holding a bit less of it than the gigantic 58 percent weighting in MSCI’s all-country index. By comparison, the US economy accounts for only a fourth of global economic activity. That high MSCI weighting comes after a decade of consistent outperformance since the 2008 banking crisis, when borrowing costs remained low and the digital revolution was accelerated by U.S.-based but distinctively global IT businesses. The benefits of diversification gained by investing elsewhere were more than offset by higher returns on U.S. stocks. However, the JPM research found that 75 percent of every 10-year U.S. outperformance or underperformance was reversed the next decade, taking the sample back 50 years. With non-U.S. equity values compared to U.S. stocks at an all-time low, Loeys and Kundu suggested that a reduction of U.S. weightings in global portfolios to about 50% may be necessary. And the remainder should be allocated to other developed stocks rather than emerging economies, which are currently hampered by dwindling prospective growth rates. The mean reversion argument points to Europe, which accounts for only 17 percent of MSCI’s all-country index. Despite this, many people are skeptical of Europe’s “cheapness” and wonder if it will be able to pick up the slack, citing low relative profitability and margins in European companies compared to those in the United States, as well as the lack of an analogous tech industry. According to Stephen Jen of hedge fund Eurizon SLJ, there are no compelling underlying reasons for European profit margins to grow from here. Furthermore, because Europe’s demographic profile is only roughly 20 years behind Japan’s, euro zone savers would continue to re-cycle the bloc’s current account surpluses offshore, as Japan has done for decades. “The market’s current preoccupation on the speed of the projected economic comeback in the coming months appears incorrect,” he said. “The discussion should focus on what might happen after the cyclical bounce that practically every economy will experience sooner or later.” @reutersMikeD, @reutersMikeD, @reutersMikeD, @reutersMikeD, @reutersM Thyagu Adinarayan created the charts, while Lisa Shumaker edited them. Continue reading