the case for Europe …and how to play

We can divide the mature stock markets of the world into three groups:  Japan, the US and Europe.

My long-held view is that Japan is a special situations market, where disastrous economic policy, hostility to foreign investors of all stripes a shrinking working population, make putting in the time to understand this intellectually fascinating culture not worth the effort for mainstream companies.

That leaves the US and UK/EU.

the case for Europe

Looking across the Atlantic, Europe appears to be a big mess.  It has, so far, not really recovered from the recession of 2008-09.  Grexit continues to be an issue, although relatively minor.  But there’s also Brexit, with the additional possibility that Scotland will vote to secede from the UK.  And there’s possibility that Marine Le Pen may become the next French president.  She advocates Frexit + repudiation of France’s euro-denominated debt.  In her stated social views, she’s the French version of Donald Trump.  On top of all this, the population of the EU is older, and is growing more slowly, than that of the US.  In a sense, the EU is the next Japan waiting for unfavorable demographics to take its toll.

What, then, could be the case for having exposure to Europe?

Three factors:

–the plus side of Donald Trump–tax reform, infrastructure, end to Congressional dysfunction–now appears to be at best a 2018 happening.  In a relative sense, then, Europe looks better than it did a few months ago

–the EU began its economic rescue operations several years later than the US did.  Because of this, one way of thinking about the EU is that it’s the US with, say, a three-year lag.  If that’s correct, we should expect growth there to be perking up–and it is–and to remain at a somewhat better than normal level for a while.

–the mass of Middle Eastern refugees pouring into the EU has produced near-term political and social problems.  However, many are young and well-educated.  So as they are assimilated, they will provide a boost to the workforce–and therefore to GDP growth.

how to play Europe

the UK

Brexit will be bad for the UK economy, I think.  Although much of the damage has already been done through depreciation of sterling, UK multinationals, especially those with exposure to the EU are, conceptually at least, the way to go.  Even here, though, it’s not yet clear how access to these markets will be restricted as the UK leaves the European Union.  So the UK probably isn’t the best way to participate.

the Continent

Since we’re talking about local GDP being unusually good, multinationals are likely to be underperformers.  EU-oriented firms will be the stars.  Small will likely outperform large.

the US and China

About a quarter of the profits of the S&P 500 are sourced in Europe.  So US-based, EU-oriented multinationals are also a way to play.

Another 10% or so of S&P earnings are China-related.  Because China’s largest trading partner is the EU, some of the glow from the EU will rub off on export-oriented Chinese firms.  Here I haven’t yet looked for names. But it may be possible to play the EU either through Chinese firms listed in the US or through US multinationals with China exposure.  I’d put this group at the tail end of any list, however.