For as long as most equity analysts can remember, Europe has trotted dutifully in tandem with the US. The received wisdom is that European equity markets are indissolubly linked to US equity markets, that European interest rate movements will always mirror US interest movements and that what the Fed says and does is always more important than what the European Central Bank says and does.
Yet now there is a suggestion that the European and US equity markets may be about to decouple. Julien Garran, a hedge fund strategist at ABN AMRO, says that while European and US economic growth may be synchronised, productivity growth is not. He suggests that this will lead to a decoupling of profit growth and a recovery in Europe.
There are several reasons for this, he says. The US and Europe have passed an ‘inflection point’ in productivity growth: the US cannot get better and Europe cannot get worse. Europe will be more robust in any global slowdown because of negative pressure on unit labour costs. There will also be a significant US dollar depreciation against the euro and a reverse in interest rate policy.
In Europe, corporate restructuring will provide the engine for growth, says Garren. “The German corporate sector has the will and the ability to achieve significant growth in productivity, although the jury is still out on France and Italy.”
Eric Chaney and AnnaMaria Grimaldi, co-heads of the European economics team at Morgan Stanley in London, also suggest that productivity per worker in the Euro-zone is picking up. And they predict that the revival in Euro-zone profitability will buoy up financial markets. “Going forward, the acceleration in productivity per employee we have signalled should be welcome in both equity and fixed income markets for its positive effects on profits and price stability.”
However, even strong supporters of Euro-zone equities are sceptical about the chance of a European decoupling from the US. Catherine Reilly, chief economist at Pohjola Asset Management in Helsinki, is sceptical about predictions of a decoupling of the European and US markets: “I would like to be able to say that it’s happening. But if you look at returns on local currencies on the local stock markets they are virtually identical in the US and Europe.
“There’s certainly no evidence that the European markets are decoupling so far European markets do seem to be driven solely by US economic data. Unfortunately European data has very little impact.”
Reilly agrees that Europe and US have reached their respective nadir and zenith in terms of market expectations – that the US has got as good as it can get and that Europe has got as bad as it can get.
“I fully endorse that idea. If you look at expectations for the Euro-zone – expectations are realistic and there’s actually upside potential to them if anything because they are very conservative, whereas in the US people keep expecting to see 4% growth year after year which is just not going to happen.
“And if you look at valuations in Europe definitely they are very reasonable –
far more reasonable than in the US. We have seen
some promising structural reforms, like in Germany the auto manufacturers re-negotiating their contracts, but I don’t know how widespread this really is.
“We’re going to have to see some concrete evidence of that really having an impact and companies profitability and manufacturing costs before the market will really believe it.
“France is now making some reforms to their pension system, but I think it’s going be a very slow process. Europe is eventually going to have to make these reforms, because it’s not going to have any choice. But it’s not going to be a rapid process.
“Euro-zone equities have a lot going for them in the long run but I don’t really see any evidence that they will significantly decouple from the US market in the short run.”