As I write, the benchmark US index, the S&P 500 is still just over 3500, with all those large cap growth stocks continuing to push ahead (last week it was Apple). The chart below, for the S&P 500, should, I suggest give, everyone some cause for concern.

What’s the alternative though to investing in these US growth stocks (cue FOMO and TINA acronyms) ?

As I’ve said on more than a few occasions, my sense is that continental Europe is a promising alternative. So far, Europe has weathered CoVid better than the Americans – though that could change. And European valuations are also relatively low, by comparison with the yanks. The chart below from European equities team at Morgan Stanley tells this story elegantly – European equities are at a 100 year low relative to US stocks (god alone knows how much worse UK stocks are).

But there’s one more tailwind worth exploring – the European markets are changing, with new sectors becoming more important to local markets. That’s the focus of an excellent special report by the Morgan Stanley European Equities team called “The changing face of European Equities”. Here’s the ten facts form the report that may surprise all readers, using data on the MSCI Europe index and GICS classifications.

#1 – “At 16% of the index, Healthcare is now the largest sector in Europe, after the biggest increase in weighting of any sector in the past decade. Pharmaceuticals is also Europe’s biggest overweight sector relative to ACWI.

#2 – Europe is no longer overweight Banks – its 6% weighting is exactly the same as for ACWI. Europe’s exposure to Banks has more than halved from 14% in 2010, and the sector is now only modestly bigger than Insurance (5%) and Diversified Financials (4%).

#3 – Energy has seen the second biggest decline in market weighting in the last decade (after Banks/Financials); it now represents just 4.3%, smaller than Utilities at 5.3%.

#4 – Consumer Staples is the second largest sector in the market after Healthcare at 15%. At 4.4% Household & Personal Products is a larger driver of MSCI Europe than Energy, Telecoms or Software.

#5 – The largest sector in MSCI Germany is not Autos or Capital Goods but Technology (14%), then Healthcare (12%). Across MSCI Europe, Semis ranks above Autos (2.4% vs
2.2%).

#6 MSCI Denmark is bigger than MSCI Italy or MSCI Spain. Denmark has been the best performing country in Europe over the last decade.

#7 The largest stock in Retailing is Prosus, then Inditex, Delivery Hero and Just Eat Takeaway. ASML is the 5th largest stock in Europe. Both Prosus and ASML are listed in
the Netherlands – MSCI Netherlands has the highest correlation of any country or sector (including Technology!) to the Nasdaq.

#8 The periphery now accounts for just 9% of MSCI Europe, down from c.14% a decade ago. The largest sector in both Italy and Spain is Utilities (not Financials). 

#9 Technology is the largest sector at 14% (using STOXX classification), followed by Personal & Household Goods and Healthcare. At <7%, index exposure to Banks is lower
than it is to Chemicals.

#10 Over the last 1-2 years there is some evidence of the SX5E decoupling from its usual positive correlation to the relative performance of: i) Europe and ii) Value. This
may be exacerbated at the upcoming rebalancing, which could see Technology/Growth stocks added at the expense of Value-oriented names.”

So, (relatively) cheap valuations, political stability, better Covid policies and a changing sectoral mix – what’s not to like ?

Oh and we can add in a recent flash number on the all important German labour market – this time from Martin Moryson, Chief Economist Europe at DWS. In sum, the Germna labour market looks like it might have hit bottom and is starting to improve. According to Martin “the rise in unemployment has been stopped, and seasonally adjusted unemployment has even fallen by 9,000. Overall, the German labor market has thus come through the crisis relatively unscathed. Employment in July was only around 621,000 or -1.4 % down on the previous year. The number of unemployed rose by 636,000 in August compared with the previous year. The seasonally adjusted unemployment rate thus remained at 6.4 %, compared with 5 % in August 2019. Or in ILO methodology: 4.4% in July 2020 after 3.0% in July 2019.

Part of this success is of course due to short-time working. According to calculations by the German Federal Employment Agency, one in six employees was on short-time work in June – but still around 600,000 fewer than in April. In the same period, the number of unemployed only rose by just under 300,000. Most of the short-time workers can therefore resume their regular jobs. So it is by no means the case, as some critics claim, that this is merely delayed unemployment. Another good sign is that the number of new applications for short-time work benefits fell to 170,000 in August – from over 8 million in April. So we can slowly see rays of hope at the end of a long tunnel. It will take quite a while before the end of the tunnel is actually reached, with 5.4 million short-time workers in June.”

I would expect the demands for some kind of short time working/reduced working week reforms to become louder here in the UK as everyone wakes up to this trend. Throwing huge amounts of UK workers into unemployment makes no sense at the moment.

India’s economic nightmare

From the very beginning of this pandemic emergency, I’ve been worrying out loud about its impact on the developing world. I was rather hoping that India would have been spared the worst, not least because it’s economy is more consumer /domestic focussed than other Asian export oriented economies. If the virus cut a swathe through India, the impact would always be horrendous – and that is what seems to have happened.

Here’s a summary from India research outfit Lalcap, with a few bright spots in bold. Maybe we are nearing the bottom of this cycle of gloom but I’d be hugely wary about Indian equities until we get a few more positive signals.

“India’s economy slumped at its steepest rate on record of 23.9% in the June quarter. This is the sharpest fall in over 40 years and will heap pressure on the government and central bank for further stimulus and a rate cut. Continuing restrictions on transport, educational institutions and restaurants – and weekly lockdowns in some states – have hit manufacturing, services and retail sales, while keeping millions of workers out of jobs. The pandemic led to a collapse in consumer spending, private investments and exports as India was under lockdown for almost half of the quarter. This is worse than the 20% contraction we forecast in our report of 5 August. Data showed that manufacturing has already entered recession as the output fell 39.3% in the June quarter after falling 1.4% in the previous quarter. However, the farm sector, which accounts for 15% of economic output, gave some hope the rural economy will be able to support millions of migrant workers who have returned to their villages. It showed annual growth of 3.4% in the April-June quarter.

India showed the deepest GDP quarterly decline among major economies. Investment demand recorded a 47% decline, while private consumption recorded a contraction of nearly 20%. With a contraction of 20.6% y-o-y the service sector, which accounts for about 60% of GDP, was a major contributor for the precipitous fall in GDP. The sector includes construction, trade, banking and financials, real estate and restaurants. India is probably already in a recession, but officially has to confirm this by reporting a contraction in the next quarter as well, which is most likely. A country is considered to be in recession if it reports contraction for two successive quarters. India was last in recession in 1980, its fourth one since independence in 1947. The bright news is that the sharp contraction in the June quarter is probably the low point, and a slow but uneven recovery is expected from hereon.”

Last but by no means least, I thought I might throw in one last chart – on an entirely different subject! Its from the index research team at MSCI and comes in a report called Is There a Green-to-Brown Premium?.

“As investors evaluate the possible reallocation of capital around the transition toward a low carbon future, MSCI Research analyzed the characteristics and performance of “green” versus “brown” companies, ultimately finding that from December 2013 to May 2020, “green” companies performed approximately in line with the MSCI ACWI Investable Market Index (IMI), while “brown” companies underperformed the index.”

These numbers help, in part, to explain why ESG funds have done so well in rennet years (and months).