Many European countries have recovered from strict lockdowns, with consumers willing to travel to places like this Paris department store.
Photo: thomas samson/Agence France-Presse/Getty Images
Perhaps the most obvious trade in the world right now is to sell U.S. stocks in the expectation that they will be hurt by the new coronavirus wave and buy stocks in Europe where it has been brought under control.
U.S. stocks are much more expensive, even as Europe reopens and many U.S. states reintroduce restrictions on business to control the viral spread. How could anything be more natural than to sell the overpriced higher-risk market and buy the cheap lower-risk market?
It is more complicated than that, and an object lesson in the perils of mapping the deluge of coronavirus-case data onto investment decisions.
Here are three reasons to question the sell-U.S.-buy-Europe trade.
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First, the stock market isn’t the economy, and national stock markets are very definitely not their national economies. Second, important parts of the economies themselves aren’t as closely tied to the restrictions as might appear. Third, and related to the first two, global risk is far more important for stocks than local risk—as shown by the tight link between stocks and the dollar.
Start with the stock market. The 295 companies in the Euro Stoxx index—the eurozone benchmark—make more of their revenue from the U.S. than they do from any single European country. At 18.6%, according to FactSet, they sell slightly more in the U.S. than in Germany (10%) and France (8.1%) combined. With less than half their sales in Europe, buying the European index isn’t the same as buying the European economy.
The same is true of the country indexes. The companies in Germany’s DAX, France’s CAC-40 and Britain’s FTSE 100 all sell more to Americans than they do domestically. Anyone buying the index to make a bet on the economy is making a mistake.
It is actually even worse, because the types of companies listed are so different. Italy’s FTSE MIB index has 21% of its value in utilities, while the DAX is only 4.5% utilities. Meanwhile, the S&P 500 is 27% technology (in addition to tech-like stocks in other sectors, such as retailer Amazon or communications services Facebook, Alphabet and Netflix ).
Big global stocks in one country generally perform much more like similar multinationals listed in another country than their compatriots in a different business.
Then there are the economies themselves. Investors increasingly track fast-moving data such as that recorded from mobile phones by Apple and Alphabet’s Google. Countries such as Italy and France have recovered from strict lockdowns, and their data shows a willingness to travel to shops, stations and workplaces.
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That might be good for stocks exposed to domestic European consumption. But be careful: Parts of the U.S. have reimposed restrictions on bars, restaurants and public gatherings, yet the data don’t show a crimp in the economic recovery—at least so far. U.S. manufacturing did slightly better than the eurozone last month (though any economic data should be handled even more carefully than usual given the huge swings this year). Thursday’s much-better-than-expected jobs report backs up the idea that the U.S. has been rebounding nicely.
Finally, there is the global interconnection of capital. When investors are worried they pile into dollars, and when they are happier they tend to invest more outside the U.S. That has created a strong link between moves in the dollar and the relative performance of U.S. and foreign stocks, even after adjusting for the value in dollars—particularly for emerging markets but also the eurozone.
Eurozone stocks began to beat U.S. stocks in mid-May, leaping 24% in dollar terms from May 15 to the high of June 8 and trouncing the S&P 500’s 13% gain. After that the market was held back by worries about a second coronavirus wave, first in China and then in the U.S., but the S&P slightly outperformed as the dollar strengthened a little.
Japanese and Korean stocks performed similarly, beating the S&P in dollar terms as the dollar weakened, and falling behind again when worries re-emerged within the U.S.
Jean Boivin, head of the BlackRock Investment Institute, argues that all these issues were just part of what he calls phase one, when investors didn’t care about local effectiveness in fighting the virus: “It was a global activity story so [stocks] got crushed either way.” He is now overweight European stocks on the basis that the economy will recover faster as Covid-19 is kept under control.
I disagree. The thing most likely to let European stocks beat the S&P is a strong U.S. recovery, allowing the dollar to weaken and global growth to accelerate. I sincerely hope that Europe doesn’t have a resurgence of the virus. But investors should remember that when America sneezes, Europe catches a cold—and if the new wave of infections leads to further U.S. lockdowns, European stocks are sure to suffer, too.
Write to James Mackintosh at James.Mackintosh@wsj.com
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