Europe's stock markets are finally having their moment in the sun

Telegraph

6 hours ago

So, what has got investors so excited?
The first point to make is that investment is a kind of zero-sum game. For money to flow into one market, it must flow out of another. And Europe's biggest advantage today is that it is not America.
As I pointed out a couple of weeks back, there are good reasons to maintain an exposure to the world's biggest stock market – demographics, energy security, easier regulation and a huge domestic economy among them. But in the short run, policy uncertainty, recession risk, an inflationary trade war and punchy valuations make a rotation out of US assets an uncontroversial trade.
There is plenty not to like about European politics. It is cumbersome, bureaucratic, over-keen on regulation and fragmented. It does not encourage innovation. It is more stakeholder than shareholder friendly. But it is predictable. It does not change its mind every five minutes. And that gets a tick from investors who, as a rule, dislike surprises.
One of the advantages of Europe's political stability has been that the ECB has been able to anticipate continuing disinflation and cut interest rates accordingly, unlike the Fed which has been forced to sit on its hands to see whether on-off tariffs will be inflationary or recessionary. President Donald Trump may call Jerome Powell 'too late', but there is a reason why the Fed chairman is not rushing to claim victory over inflation.
The ECB has halved its interest rate to 2pc, and monetary policy will contribute to the region's growth outlook this year and next. So, too, will fiscal policy, with the International Monetary Fund estimating that a looser tax framework will deliver a 1.6 percentage point stimulus in Germany and 0.8pc in France.
At the heart of this is a blueprint to improve Europe's military readiness through higher defence spending.
Member states will be able to deviate from the EU's fiscal rules to buy tanks, guns and military tech. Germany alone is planning to spend an additional €500bn.
After years in which the engine of European growth sputtered along in second gear, there is the prospect of a multi-year period of turbocharged military-industrial investment. America's reluctance to backstop European defence has been a gift.
There is a question mark over the speed and extent to which this feeds through into growth. There is further doubt as to which companies will ultimately benefit from the increased spending. There is many a slip 'twixt cup and mouth, and the soaraway share prices of businesses such as Rheinmetall may well come back to bite investors who have tried to get ahead of the curve.
But earnings follow economic growth and, at the margin, analysts' forecasts for European companies are nudging higher at the same time as those for their US counterparts are in decline.
Earnings expectations are important because, for years, the US's valuation premium has been justified by the greater profitability of US companies. If US and European valuations are to move closer, it will only be on the back of a narrowing earnings gap.
Another important advantage that Europe has over the US is the greater income it offers investors. An average dividend yield of more than 3pc is twice that paid by US companies, and more European companies pay a dividend at all (93pc versus 75pc). Goldman Sachs expects European companies to return 5pc of their value to shareholders through dividends and share buybacks this year versus 4pc for US companies.
Of course, there are risks with a shift away from the US towards Europe. A weakening dollar will reduce the value on translation of the quarter or so of European company profits that is earned in America. Trade uncertainty remains significant as we approach the end of the 90-day tariff pause. But after years in which investment portfolios have become over reliant on the US, there is scope for at least some of that money to find its way back home.