Will investors continue to choose US over Europe?

Published: Mar 2020

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An ultra-left-wing Democratic presidential candidate – by American standards – who has the wind in his sails, European industry that is dealt blow after blow and a virus triggering global unrest. These are just a few developments that could give rise to pessimism about the global economic outlook.

Partnership concept between the EU and USA

However, investors in the US and Europe don’t seem to be concerned at the time of writing. US shares have been performing significantly better than European shares. Furthermore, EUR/USD reflects higher investor confidence in the US economy versus the European economy. Do political developments suggest persistent higher confidence in the US financial markets this year?

Europe is faced with the following obstacles to a substantial improvement in economic growth.

Germany – which is widely regarded as the continent’s leader – is struggling with internal political problems, as Chancellor Angela Merkel’s intended successor stepped aside following a series of setbacks. The last straw was Annegret Kramp-Karrenbauer’s (AKK) role in the uproar surrounding the election of Thuringia’s state premier, where the regional branch of Merkel’s and AKK’s CDU, together with the Alternative für Deutschland (AfD), helped a liberal politician win the vote. This sent shockwaves across Germany, as it was considered to legitimise and endorse collaboration with the AfD – which is regarded as extreme right. AKK seemed to have lost control once again, with Merkel being forced to put things right. Elections are not scheduled until the autumn of 2021, but speculation on a premature end to Merkel’s final term is rife now. Political instability in Germany will make it more difficult to steer a clear and dynamic European course.

Meanwhile, French President Macron tries to seize his chance to leave his mark on Europe. Macron is seeking to position France as Europe’s geopolitical leader, and he wants to keep involving Britain – probably because Britain and France are the only European nuclear powers and the only countries that are able to flex military muscle. In addition, by keeping the UK closely involved in European matters, Macron wants to ensure that Germany does not run the show alone.

Macron basically only tries to achieve what his predecessors wanted to achieve: using Europe as a vehicle to boost France’s international position. France does not primarily regard itself as a player that strengthens Europe; it regards Europe as an entity that supports its global ambitions.

New European power structures will crystallise in the coming years, as Britain has turned away from Europe, the giant economic gap between France and Germany continues to widen, and Germany will slowly but surely play the political cards where it was previously reluctant to do so in view of its history. In addition, the Eastern countries – led by Poland – are increasingly making their voices heard.

Europe may not be rudderless, but it lacks a clear course. On the upside, Europe was (fairly) united in the Brexit negotiations, policy in respect of Russia has, surprisingly enough, proved fairly consistent and coherent in recent years, and Brussels continues to conclude free trade agreements. On the other hand, Europe is at risk of gradually being driven apart by China and Russia, support for NATO is plummeting and European refugee/migration policy is embarrassing.

The latter could cause European tensions to flare up this year. Western Africa is faced with a growing number of extremist attacks, violence is flaring up and national governments seem unable to curb it and, in some cases, make it worse. Furthermore, the civil war in Libya and the escalation in Syria between Turkey and troops of Syrian dictator Assad (supported by Russia) create an increasing risk of massive refugee flows to Europe.

In addition to the issues mentioned earlier, Europe – as the world’s largest trading bloc with a fairly open economy – is still very vulnerable to protectionist trends and a further spread of the new coronavirus (officially referred to as COVID-19). The combined damage of an escalating trade war and the impact of the coronavirus may push Europe over the edge into a recession – also because recent economic data hasn’t been very upbeat.

Policymakers and the ECB will have to absorb the impact if Europe is unexpectedly hit hard. However, they lack the resources to absorb such shocks, partly because the ECB’s interest rates are at negative levels, and total debt positions in Europe are exceedingly high. In addition, many policymakers are wary of raising deficits. If a crisis situation arises, financial markets are likely to doubt, once again, whether the monetary union will be able to survive.

However, we suspect that Trump will put his animosity towards Europe on hold, as he does not want to break the economic momentum he has achieved in the run-up to the November elections. Incidentally, this momentum is fairly relative. US growth has fallen back to just above 2% – while Trump promised a growth rate of 3% or higher – and many Americans have only enjoyed little improvement in their situation in recent years. Yet 59% of Americans say that they are in better economic shape than a year ago and three-quarters believe that their situation will have improved in a year from now.

We believe a second term for Trump is the most likely scenario at this point. The stock markets will receive an additional boost as Trump’s chances increase. It is only in the longer term that the markets will be preoccupied with the structural damage that Trump is inflicting on the US economy – by inflating budget deficits to far higher levels, by undermining productivity – due to limited focus on, and funds for, training and education – and by continuing to erode international economic organisations and cooperation. In the shorter term, investors will mainly relish the prospect of more tax cuts, further deregulation and the further unleashing of so-called animal spirits in the US economy.

All this means that, from a political perspective, this year will see investors leaning more towards the US than towards Europe – even though US shares and the dollar seem to be overvalued. Europe is faced with too much political uncertainty and it makes too little progress. If Europe wants to be able to compete against giant companies in the US and China, it should not fight internally about a few billion euros more or less for the European budget.

In addition, we believe the immediate external threats for Europe are greater and more urgent than those for the US. We have discussed the pressure on European borders from North Africa and the Middle East. Moreover, Europe is more vulnerable to a decline in global trade than the US. Finally, whichever way you look at it, the EU has been weakened considerably – militarily, politically and economically – by the departure of Britain. The EU has lost the second largest economy and one eighth of its population. One could argue that the EU is able to move ahead now because the obstructionist UK will no longer be able to block policies, but this remains to be seen.

From a political point of view, European shares are therefore less likely to outperform US shares this year. In addition, the euro is unlikely to have a great deal of upside potential against the dollar. However, our technical analysts suspect that European shares could perform slightly better than US shares, based on the current unprecedented outperformance of US shares versus European shares.

In the longer term, the US will certainly be affected by Trump’s actions. Investor confidence is bound to be damaged by Trump’s policy of blocking competition, inflating deficits, alienating allies, undermining the Fed’s independence and neglecting education, and so on. The dollar is likely to become a very weak currency by that time.

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