Ryder Cup: Europe vs US investment showdown27 September 2016
With the start of the Ryder Cup this weekend, the biennial golfing competition between teams from Europe and the United States, this might also seem a good time to assess the relative investment case for US equities versus European equities. Jason Hollands, Managing Director of Tilney Bestinvest, argues both regions face political upheaval and economic challenges but relative valuations and the prospect of divergent monetary policies might give European equities a slight edge.
Hollands comments: "With the first of three US Presidential TV debates over, the most contentious US election in recent history which pits two candidates that polarise opinion against each other is sure to take increased prominence in driving daily market moves as Election Day approaches.
"Indeed last night's perceived win by Hillary Clinton is believed to have spurred a rally in the Mexican Peso, as Donald Trump advocates aggressive policies to stem the flow of people and goods across America's southern border, and a softening of defensive assets such as Gold. Yet with several weeks to go and some polls suggesting a neck and neck race, the outcome looks too close to call at this stage.
"While a Trump win would likely spook the markets - emerging markets in particular given his advocacy of high tariffs - whichever candidate wins could face resistance from Congress to their policies. The election has further exposed deep fault lines in American society that neither candidate seems positioned to heal.
"But Europe also faces political headwinds as it reels from the challenge that Brexit poses to its future and widespread dissent to the EU which has been fuelled by the migration crisis. While US politics is taking centre stage now, next year's elections in France and Germany will be major tests for incumbent leaders.
"Irrespective of the outcome of the US elections there are continued signs that the US Federal Reserve - who’s Chair Janet Yellen was accused by Mr. Trump last night of keeping interest rates deliberately low for political reasons - is readying to raise rates again before the end of the year. It has been itching to do so for months. Such a move would mark a greater divergence in monetary policy between the US and Europe where the European Central Bank (ECB) has moved to negative interest rates and continues to buy up vast amounts of bonds to keep borrowing costs down. Expectations are building that the ECB may even further step up actions as it struggles to kick start growth.
"On past form investment in these two regions paints a very decisive picture with America's S&P 500 Index delivering a total return of 121.54% over the five years to the end of August. In contrast European equities have lagged far behind with a 74.51% return from the Europe ex UK Index. Yet it is important to remember that this was a period when the US market benefitted from vast stimulus programmes provided by the Fed that enabled companies to borrow money incredibly cheaply and often use this to buyback their own shares. The coming years are expected to see borrowing costs rise, so the monetary policy outlook from here is probably going to be more favourable for European equities.
"The underlying growth outlook for both regions is hardly compelling. US corporate profits have peaked and the dividend outlook in Europe is very uncertain. In such an environment it is important not to overpay for assets unless you are really convinced that the earnings of a particular business are so resilient they can buck the economic trend.
"From a valuation perspective, European equities have the edge though are far from "cheap". While the US market is trading on a cyclically adjusted price earnings multiple of almost 25 times earnings - considerably above its long term median - developed market European shares, are just below 15 times but this is flattered by the fact that UK shares are on a cyclically adjusted price earnings multiple of 13.7 times.
"What is startling however is the markedly different fortunes of fund managers in these two regions. The last five years have seen managers of US equity funds struggle to keep up with a bull market in US shares lifted on a tide of cheap money. Staggeringly just five funds in the IA North American sector - little more than 6% of the universe - beat the S&P 500 Index after costs over this period. No wonder then that many investors have given up entirely on active funds for their US exposure, choosing low cost trackers instead.
"However, in the Europe ex UK sector it is a different picture altogether with 65.8% of funds beating the FTSE Word Europe ex UK Index over this period and a similarly convincing picture also appears in the UK's All Companies sector too.
"So in summary, both sides of the Atlantic face the potential for political shocks, the underlying growth outlook is weak and valuations are rich. It's hard to be bullish from here about either region. Investors need to be very careful however about extrapolating the stellar returns from US equities of recent years into the future at a time when monetary policy is expected to diverge further between the US and Europe and the degree of support to US equities from ultra-accommodative money policy abates. In terms of the monetary policy back drop and valuations, European equities have a slight edge but above all it is important to tread with care. In uncertain times we expect active managers to have greater potential to out perform."
PowerShares FTSE RAFI 1000 ETF - an exchange traded fund that holds the 1,000 largest US stocks but weights exposure according to a combination of cash flow, sales, dividends and net assets. This provides a more defensive profile than a traditional tracker. Annual costs are 0.39%
Dodge & Cox Worldwide US Stock - this is an actively managed fund run from San Francisco with a defensive, value bias. Annual costs 0.7%
Vanguard S&P 500 UCITS ETF - an exchange traded fund that follows a traditional market-cap weighted tracking approach with very low 0.07% annual costs
Threadneedle Europe Select - our long standing top pick for Europe, this fund has a buy and hold approach focused on quality growth companies with an emphasis on strong brands such as L'Oreal and Richemont. Ongoing costs of 0.83%
Jupiter European - an unconstrained and concentrated portfolio of 30-40 high growth companies. Annual charges of 1.03%
Baring Europe Select - a highly diversified portfolio of small and mid-sized European companies selected with a "Growth At A Reasonable Price" (GARP) approach. Annual charges of 0.81%
Note: all charges based on those available via our Bestinvest Online Investment Service.
The value of investments, and the income derived from them, can go down as well as up and you can get back less than you originally invested. Past performance is not a guide to future performance. This press release does not constitute personal advice. If you are in doubt as to the suitability of an investment please contact one of our advisers.
Different funds carry varying levels of risk depending on the geographical region and industry sector in which they invest. You should make yourself aware of these specific risks prior to investing.
Tracker funds track the performance of a financial index and as such their value can go down as well as up, much like shares, and you can get back less than you originally invested. Some are more complex so you should ensure you read the documentation provided to ensure you fully understand the risks. ETFs can be high risk and complex and may not be suitable for retail investors, so you should make sure you understand all the risks involved before investing.
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