The argument for owning European equities
Investors should hold their noses and revisit Spanish and Italian bank shares
In this column last month, I covered non-US stocks’ historical leadership in US presidents’ inaugural years. History shows us that the party really gets going in the second half, making this your buying window. But what to own? For answers, look at sector and country winners from the first quarter of this year.
Since 1970 — when good sector data begin — non-US sectors that led in the first quarter of inaugural years led for the rest of the year. The first quarter’s top three non-US sectors led the MSCI EAFE Index (Europe, Australasia, Far East) 61 per cent of the time, by a median 3.4 per cent. Meanwhile, the three worst sectors trailed the rest of the year 76 per cent of the time by -4.8 per cent.
Country leadership also persists. Similarly, the first quarter’s top country or region led the rest of the year 80 per cent of the time, by a median 5.6 per cent. The second best kept leading 60 per cent of the time, with a 2.2 per cent spread. The worst kept lagging 60 per cent of the time, and by 6.2 per cent.
“No correlation without causation” is one of my pet rules. “No heat chasing” is another. But I see fundamental reasons why many first quarter trends continue. The drivers don’t suddenly shift when the calendar flips from March to April. With America’s new administration in place, falling political uncertainty had already given its bullish impact on US stocks, hence first-quarter growth has favoured non-US stocks. And when non-US stocks lead early in inaugural years, the outperformance usually grows with time.
Outside America, many nations are very sector heavy. So if you expect non-US stocks to lead, that impacts sectors too.
On a regional basis, the first quarter’s best were Australia and continental Europe, while Canada lagged behind badly. Of the 10 eurozone nations in the MSCI World Index, seven outperformed. So buy Europe — not just core stalwarts like Germany, the Netherlands and France, but also the periphery.
Spain was the single best-performing country in the first quarter, and midway through May, its lead has widened. Australia, however, has sagged, and I see it as part of the 20 per cent that reverses first quarter success historically. Aussie stocks are a heavy bet on materials, whose early-year bounce petered out as folks fathomed metals’ enduring supply glut.
As for sectors, in the first quarter, non-US’s best sectors were technology, healthcare, industrials, consumer staples and utilities. The worst were energy — hence commodity-heavy Canada’s lag — plus telecoms and discretionary consumer stocks.
I’ve long liked healthcare and tech and expect greatness from here. Global demand for drugs, gadgets and software likely stays sky-high through this cycle’s close. Buy industrials, but avoid those dependent on commodity prices — aerospace, diversified conglomerates and consumer-goods manufacturers have better potential. As for staples and utilities, own some but don’t go crazy. Both tend to lag during strong expansions. Maybe they’ll be part of the 39 per cent that flip-flops.
Financials are a special case. Globally, financials lagged behind in the first quarter and kept trailing. But eurozone financials led in the first quarter, and have sped up since. Buy them.
US loan growth is slowing, but eurozone lending is ramping up, and banks there are loosening. Based on senior loan officer opinion surveys from the Federal Reserve and ECB, eurozone credit availability has improved since early 2016, while US loan supply has tightened.
In America, more banks tightened than loosened in three of the last four quarters. In Europe, banks net loosened in three of four quarters. In the one quarter that more banks tightened (the fourth quarter of 2016) the difference was only 0.2 per cent — so basically even. Lending trends tend to follow changes in credit standards, so Europe’s looser stance argues for ever-faster loan growth.
Historically, relative credit availability has correlated with outperformance. For most of the 2002-07 bull market, eurozone banks lent more eagerly than US banks, and eurozone stocks outperformed US — by 182 per cent to 61 per cent over the whole bull run.
For this bull market’s first few years, we had the opposite — looser lending in America and US outperformance. Yet for the past year, there has been a fairly big disconnect between relative credit access and relative returns.
Even as eurozone credit improved, US markets outperformed — until just recently. Investors were too distracted by politics to fathom faster loan growth’s implications. The French election’s conclusion should help folks refocus.
Eurozone leadership is only just starting. Europe’s credit cycle is young. Banks have ample room to expand balance sheets and improve non-performing loan ratios.
America’s cycle is older. US banks have been expanding balance sheets for five years, and non-performing loan ratios are about as good as can be. US banks are healthy, stocks already reflect that. Yet investors still broadly hate eurozone banks. Their relatively brighter future isn’t priced yet. That goes double for Spanish and Italian banks — hated currently for no good reason, just bitter memories. Hold your nose and buy now.
Ken Fisher is the founder and Chairman of Fisher Investments