2017 A Year So Far – US and Europe
US equities continue to be the most expensive market in the world and now trade on a significant premium to the rest of the global equities by most valuation metrics. The justification for this is that the pro-growth policies of Donald Trump will both stimulate the economy, enhance company profitability and reduce the corporate tax burden. It is highly debatable that all of the above will be achieved to their fully promised extent. Any shortfall in the major policies may lead to a revaluation of the equity market. However, while the market is highly priced, it could remain this way for some time.
The US market has seen the sharpest rotation into “value” stocks, particularly banks. It is anticipated that higher inflation, interest rates and lower regulation will significantly increase their profitability.
European equities are now looking attractively valued compared to US counterparts. Europe does typically trade at a discount, however, there does now look like there is a significant disconnect. The political clouds over Europe as well as the relative euphoria in the US has driven a wedge in valuations between these markets.
The economic situation in Europe has improved dramatically over the last year. Employment has grown, inflation has recovered from the deflationary danger zone, and the use of extraordinary monetary policy appears to be coming to an end. Importantly, the Euro yield curve has steepened which will enhance bank profitability and will hopefully accelerate the healing of the sector, leading to a resurgence in lending, leading to boosting economic performance.
Politics has been the main focus of investors in the European markets. There is a concern that the populist victories in the UK and US would lead to similar results in Europe. The first test, the Dutch election passed without a drama although there were strong gains for the populist candidate Geert Wilders. The upcoming French presidential election is likely lead to a second place standing for Marine Le Pen in April/May. While there is of course a possibility that Le Pen will win, the impact may well be oversold as she is likely to face struggles to pass all of her manifesto pledges. The most concerning policies, such as breaking up the Euro and EU may well prove impossible. Finally German elections in September are unlikely to lead to a populist Chancellor, although it may become more challenging for the incumbent parties to form a working coalition, which may result in some volatility.
While there is enhanced political risk in Europe, higher political risk is now present in all major markets. There is an extreme tail risk to this year’s elections although these appear to be outweighed by the relative valuations on offer.