(Bloomberg) -- A dormant stock market, brittle currency, crisis-ridden political system, stagnant economy — so was the landscape in Europe even before Donald Trump won election in the US.
Now, the continent faces new trade tariffs against its biggest companies and investment outflows as Trump's plans to cut taxes and gut regulation make US stocks more attractive. Add to that the growing angst around Germany's upcoming snap election and escalating Russia tensions and even the most optimistic investors are struggling to stay upbeat.
“Europe is hit from all sides and you have risk aversion coming back,” said Luca Paolini, chief strategist at Pictet Asset Management, a Swiss-based asset manager. “It’s difficult to see what can save it.”
In the days since the US election, European stocks have retreated, outflows have picked up and the euro has skidded towards parity with the dollar, reinforcing an unequal status quo that took hold years ago: Europe generates weaker economic growth than the US and, in turn, far less wealth for those who invest in its financial markets.
The US equity market has always been bigger than Europe’s, but the gap has widened significantly in the past 10 years, in large part due to the emergence of multi-trillion dollar firms like Apple Inc. and Nvidia Corp. At $63 trillion, the total market capitalization of US stocks is now four times bigger than all of Europe’s bourses combined. Ten years ago it wasn’t even twice the size.
Another stark indicator is the size of each market’s biggest companies. Europe doesn’t have a single public firm valued at over $500 billion. The US has eight worth more than $1 trillion.
“There’s always been a liquidity gap, but the key thing is how big that gap has now got,” said Helen Jewell, chief investment officer at BlackRock Fundamental Equities EMEA. She estimates that liquidity, as measured by market capitalization traded, is five times higher in the US than in Europe.
The divergence has created a feedback loop that’s growing increasingly hard for Europe to get out of: Over 71% of passive investments to benchmarks tracking the popular MSCI World Index are automatically allocated to the US. That, combined with sluggish economic growth, pockets of political instability and tighter fiscal policy has led European stocks to underperform the US in eight of the past 10 years.
Now, the trend is being turbocharged by Trump’s proposed policy mix of tariffs, deregulation, loose fiscal policy and tax cuts. Europe’s benchmark stock index, the Stoxx 600, is trading at a record 40% discount to the S&P 500 and this year’s underperformance is on track to be among the worst on record. The euro has slumped to its weakest level in over a year, with many strategists predicting a slide to parity with the dollar in the months ahead.
“US exceptionalism remains the playbook into 2025,” strategists at Barclays Plc including Emmanuel Cau wrote in a research note published on Friday. “It is hard to argue for changing fortunes” in Europe, they said.
Of course, there’s a lot that can change over the next four years and many are betting that the hype around so-called Trump trades will fade as the reality of the potential impact his policies will have on inflation sets in. Strategists at Bank of America Corp. on Friday made a contrarian call to buy European stocks ahead of Trump’s inauguration on the expectation that Trump’s tariff plans will prompt the European Central Bank to aggressively cut interest rates.
Jon Levy, a macro strategist at Loomis Sayles, argues that Trump’s America First agenda may be just the jolt Europe needs to force it to take action on improving the attractiveness of its assets. The likely change of government in Germany may also prompt a shift to looser fiscal policy, which could boost growth, he said.
“It’s not a low growth, low rates forever type of trap,” Levy said. “For all Trump’s actions there are counteractions and those matter just as much.”
Blackrock’s Jewell argues that global investors will also still want to keep a portion of their portfolios in European assets throughout the Trump presidency to avoid too much concentration in US assets. But the very fact that the continent’s stocks are being heralded as a “diversifier” speaks to how marginal their role has become on the global stage.
The bond market is sending a strong signal that Trump’s spending plan will worsen the economic disparity between the US and Europe by opening up the biggest gap between short-dated German and US yields in nearly two years. Traders are wagering that there’s a 20% chance the ECB will slash rates by a half-point at its December meeting, with 1.4 percentage points of reductions priced in through October next year. In the US, traders are betting on half that amount of easing.Goldman Sachs Group Inc. strategists cut their 12-month forecast on European equities on Tuesday, citing a tepid economic backdrop, modest profit growth and share valuations close to the long-term average.
Goldman, JPMorgan Chase & Co., and Citigroup Inc. have singled out the euro as one of the most vulnerable currencies to Trump’s tariff agenda. Given Europe’s reliance on manufacturing exports and exposure to China, they forecast a slide near to or even below parity in the months ahead.
“The euro-dollar to parity view is only gaining, not losing, momentum,” said Brad Bechtel, global head of FX at Jefferies. “Regardless of how oversold, I say the momentum in the pair is very strong and the party is still raging.”
--With assistance from Farah Elbahrawy, Alice Gledhill and Margaryta Kirakosian.
(Updates to add line on Russia tensions in second paragraph and details of Goldman Sach’s latest forecast in third to last paragraph.)
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