There is a time for everything – and now the time has come for us to lift US equities to overweight in our portfolios and at the same time reduce European equities to a neutral weighting. Going forward, we see greater return potential and less risk in US equities – for a number of reasons:
- TRADE WAR: Whereas we previously expected a relatively speedy resolution to the trade war between the US and China, it has become increasingly obvious during the year that the two parties are unlikely to reach a deal any time soon. At Danske Bank, we now expect a deal in 2020 at the earliest – and to date US equities have performed better than other equity markets when the trade war has ratcheted higher and uncertainty has soared. We expect this will also be the case going forward.
- SECTOR DISTRIBUTION: Sector distribution supports an overweight in US equities in preference to European equities. Industrials and financials are more heavily weighted in the European equity market, and these sectors have been particularly hard hit by, respectively, the trade war and the historically low level of interest rates in Europe, which is squeezing bank earnings. While many companies are a little reluctant to make major investments in machinery and so on, which is hitting the industrial sector, companies are still generally prioritising investments in software and data security, and these services are more commonly found among US equities.
- BREXIT: On top of this comes the uncertainty of Brexit, where the next deadline for the UK is 31 October. What will happen is a complete unknown at the moment, and this increases the risk associated with UK equities, which comprise more than 26% of the European equity index MSCI Europe. All else being equal, the uncertainty will cause investors to require a higher risk premium for investing in UK equities, which is thus yet another drag on European equities.
- MONETARY POLICY: The trade war and slowing global growth have prompted central banks to adopt accommodative monetary policies to stimulate the economy. Here, the US central bank, the Fed, simply has more ammunition to shoot with than the European central bank, the ECB, when it comes to the scope of future monetary policy easing measures.
- PRIVATE CONSUMPTION: And last but not least, strong private consumption is the other factor along with accommodative central banks that is keeping the economy afloat at the moment – and consumption appears strongest in the US, while the US equity market also offers a greater share of companies within cyclical and digital consumption.
Equities more expensive in the US – but worth it
In our view, the above factors justify the higher valuation on US equities compared to other markets, just as the high valuation also reflects the US having more growth companies within technology, etc. Moreover, US companies are generally expected to report higher earnings growth than European companies in 2020.
While the US president, Donald Trump, is very unpredictable when dealing with other countries, his approach is more consistent when it comes to his own country. He is focused on voter opinions and convinced the US economy is very much being driven by consumers – ie, voters. In our view, he will therefore continue to go far in his political endeavours to keep consumers happy – just consider his recent move to delay additional tariffs on selected Chinese goods, such as mobile phones and laptops, in order to rescue Christmas shopping for US consumers.
Politics could kick-start Europe
While we now have a significantly more negative view on European equities than earlier this year, we are also certain that Europe’s woes are largely down to politics – and things in the political sphere can from time to time develop very quickly and surprisingly.
Should, for example, a trade deal between the US and China materialise earlier than expected, and/or Brexit get resolved positively, this could totally change the perspective for European equities – and then there is German fiscal policy, which is a strong joker waiting in the wings. The German economy is limping badly, and debate is increasing in the country about the potential for fiscal stimulation to kick-start the economy – which could prove a major boost for equities. This is why we have a neutral weight in European equities and not an underweight.
Disclaimer: Danske Bank has prepared this material for information purposes only, and it does not constitute investment advice. Always speak to an advisor if you are considering making an investment based on this material to establish whether a particular investment suits your investment profile, including your risk appetite, investment horizon and ability to absorb a loss.