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This column has always been about helping readers based on honesty and experience. So let me begin this week by warning you off sailing holidays with a partner and kids. Especially in summer.
Proximity to water doesn’t cool you down enough. I would like to say I enjoyed at least some peaceful nights alone on the boat after my family mutinied and rowed to an air-conditioned hotel. But it was too hot to sleep. And our fridge broke — ruining my emergency beers.
I certainly didn’t have the energy to follow the markets, despite a better phone signal in the middle of the Mediterranean Sea than I get at home. Luckily, it mattered not. After a sell-off and then a rebound, my portfolio hasn’t moved much.
So where were we then? You may recall in my last column that two things were playing on my mind: my overweight position in UK equities and the opposite for Europe. Has anything of substance changed, save for a wife no longer talking to me?
In the UK at least, it’s been a lesson in not acting in haste. The FTSE 100 has surged since I questioned its post-Iran war valuation — both relative to history and the outlook for earnings. My exposure is north of 30 per cent again.
I’m grateful, but frankly surprised. One pillar of my portfolio construction is the idea that a tech sell-off in the US would lead to weaker bourses elsewhere due to the size of the stocks as well as how much optimism for the future relies on them.
It is why it never made sense for me to own zero US while holding chunky weightings in other equity markets. If I were genuinely worried about the so-called Magnificent Seven, then God help everyone. This logic is being tested.
The rally in the UK a fortnight ago was partly driven by investors fleeing the US for cheaper shares with less exposure to artificial intelligence. Sure, a lower British inflation number didn’t hurt, nor the odd earnings upgrade. Did a new prime minister help? I doubt it.
If the rest of the world holds up when US shares come under pressure, those of us who fret over AI valuations needn’t worry. We can turn our backs on Wall Street and still place bets on other stock markets.
The trouble with this line of thinking is that it rarely works — as I know better than most. After running Japanese equity portfolios in my youth, I managed what they called EAFE (Europe, Australasia and the Far East) funds.
These provided a way for US (and Canadian, bless them) clients to gain easy exposure beyond their home markets. And, sure enough, when the S&P 500 was having a wobble, our phones rang. This is it, we would hope. Our time has come!
Except it never lasted long. Soon US shares would be trumping all comers again. Domestic investors would cease looking beyond their shores. This is why I’m loath to love the FTSE 100 as an anti-Nasdaq or whatever.
Money that rotates is speculative by definition, no matter how attractive the relative valuations are. These Johnny-come-lately investors will be gone come the next earnings beat by Google or whenever the OpenAI roadshow comes to town.
You can see this clearly in the flow data, for example from LSEG Lipper. During our first week at sea when tech stocks were tumbling, US equity funds suffered almost $10bn of outflows. Flows into European funds, including the UK, were of a similar magnitude.
It’s not a straight swap. And the datasets are volatile. Remember, too, that flows themselves don’t cause shares to rise and fall, as I bang on about. US money doesn’t enter the UK market — there are sellers on the other side. Rather, prices are bid up, often irrespective of underlying earnings.
And that is what happened, it seems to me, while I was desperately trying to get some air below decks for 14 nights. Rotational buying merely pushed valuation multiples higher. Therefore, to my mind, the UK is even less attractive than it was.
While switching out of the US partly explains the strong returns in Europe too — the benchmark Stoxx 600 index made another high this week and has bagged four positive months on the trot — there is more going on.
Earnings have been surprising many — up about 15 per cent in the second quarter with more than half of companies beating estimates. Europe is even outperforming the US, reducing its forward price/earnings discount to the S&P 500 to 23 per cent, according to Bloomberg data. This is the smallest gap since 2022.
Like the US investors who stray from home every so often, though, I’ve heard this “Europe is slightly less relatively crap than it was” story a million times. Absolute gains are usually less impressive. For example, net profits for the median Stoxx 600 company are only 7 per cent up on a year ago. (The US equivalent is more than half that again.)
Nor is beating continually revised estimates ever worth crowing about. And European stocks now trade above their long-run average on a price/earnings basis. I don’t have a massive problem with that, but I do with the Stoxx 600’s shrinking valuation discount to the S&P 500.
Should European valuations be three-quarters as pricey as US ones? Not in my view. More like half. As an equity investor, I’d definitely back the average US company to make me my money back twice as quickly.
For starters, having just sailed around Ibiza and Formentera, I know for a fact where most of Europe’s bosses are now. And with air con on their superyachts, they aren’t returning to work early like my wife did.
More on this next week. Mulling over the case for European equities, that is, not my marriage.
The author is a former portfolio manager. Email: [email protected]
