EU outperformance

Since the middle of last July, the S&P 500 is up by 8.7%.  Over the same time span, large-cap EU stocks have risen by almost 14% in € terms–and the € has risen by almost 5% against the $–meaning close to a 20% return for dollar-oriented investors.

Will this relative strength continue?

I think so.

Here’s why:

favorable circumstances

–the EU has finally put the worst of the Great Recession behind it and is beginning to recover

–the US continues to expand, but its alleleration will be lower than the EU’s

–the new Chinese administration is undertaking two necessary economic reforms, both of which will slow near-term economic growth and (I think) create uncertainty.  (The two: wresting control of banks from local/regional governments, and shifting away from low value-added export-oriented manufacturing.)  /so Pacific Basin growth will likely be less dynamic this year than usual, as well

either/or

So far, good news about the EU has expressed itself in both currency appreciation and in a rise in local currency stock prices.  My guess is that the € won’t weaken, but that most of the currency gain has already happened.  I expect the strongest areas of the EU market will continue to be early business cycle domestic-oriented areas, however.  The extent of underperformance by multinationals listed in the EU will probably be a function of the strength of the €.

a cyclical phenomenon

Eurosclerosis is the word coined to characterize the pre-EU European economy.  It meant sub-scale firms, excessive regulation, intra-European protective barriers, rigid labor, high unemployment and an aging population.

The launch of the € has resulted in transparent (and lower) pricing throughout the EU, M&A to create world-scale firms, and the elimination of intra-EU customs/tariff barriers.

But the union is still stuck with rigid labor, an aging population and vigorous defenders of their national economies in France and Italy, two of the three largest countries in the EU.  So eurosclerosis isn’t behind us.  We’ve got eurosclerosis 2.0 instead.

In other words, playing the EU is a business cycle idea, made more interesting by lack of oomph in North America and in the Pacific.  But we can’t forget to sell–probably some time late this year.