Well, here we are. Just 54 days until a new decade dawns. These milestones tend to prompt a little bit of reflection albeit I do try to avoid the mirror for illustrations of the ravages of time. On a more constructive note, time is typically an investor’s friend as the miracle of compounding over multi-year periods can deliver surprisingly strong returns.

If we reflect on Europe’s financial decade there has been no shortage of millstones to weigh on performance. Take your pick from the recession, sclerotic growth, banking woes, sovereign debt crises, Greece or BBBBBrexit. Would you be surprised to know that European equities managed to carve out a total return of 92.7% since October 2009?

Thanks to the analytics team at Albert Bridge Capital we were pleasantly surprised to find out that the annualised return for European equities(MSCI Europe Index) was a solid 6.9% per annum over the ten year period. That’s pretty much what any wealth advisor will assume over the long run as a return for perceived higher-risk equities. So all ok then? Not quite.

Obviously, the starting point for measuring performance is somewhat helpful given markets had plummeted in 2008-2009 during the global credit crisis. However, like most things in finance, exploration of relative performance can generate a better understanding and potential insights. In the same Albert Bridge report, we learned that US markets have had a much better decade. Total returns for the S&P 500 since October 2009 were 233.8%. That equates to an annualized return of 13% per annum or almost double the annual rates of return achieved by investors in Europe.

There might be some readers who feel the US typically has been the superior performing market due to business-friendly regulations/taxes, deeper capital markets plus a vibrant tech sector. That’s where things get quite interesting. If we look at the previous three decades from 1979 to 2009 the bull market delivered total returns of over 2500% or 11.5% per annum for US investors. Amazingly, returns for European investors were exactly the same! So the question is why has the relationship broken down in the past decade?

My own personal focus in previous articles has been the stubborn stall speed of European equities for pretty much the last 5 years. European equities have gone precisely nowhere in performance terms since April 2015. The US market has accelerated in the same 5 year period by a further 50%. It is possibly a little early to definitively explain the divergence in performance and we have noted recently belated signs of life in European equities(mean reversion anybody?). However, the following observations are worth some consideration.

  1. The US technology sector has a vastly bigger weighting in the US market than that of tech in the equivalent European index. The big tech winners like Microsoft, Apple and Amazon have accounted for a large portion of overall market performance. It is worth recalling the famous statistic from Hendrick Bessembinder’s “Do Stocks Outperform Treasury Bills?”. Bessembinder found in his study of US equities markets that the best performing 4% of stocks were responsible for all the wealth created in the stock market from 1926 through to 2018! It could be the case that the US has had a small number of very significant tech winners in the past 10 years.
  2. If we look at the European market index one can’t help noticing that there is a very big weighting attached to the banks’ sector. This is one of the sectors most challenged by technology as well as unresolved bad debts. The Japanese experience will inform readers that this can be a performance killer for decades. There’s another interesting point to make about “losers” or underperforming stocks. By avoiding losers(difficult) overall portfolio performance can dramatically improve. The research team at OSAM found that if the bottom 25% of performers were excluded since 1994 one would have enjoyed annualized returns of 22% per annum over the subsequent 25 years to today. Think how Europe would have performed in the past 5 years without its banking sector.
  3. My own preferred focus is the unintended impact of the relative difference in interest rates between the US and Europe. With zero interest rates in Europe, zombie companies(and banks) have been able to survive and continue to consume capital which otherwise might have funded a new Amazon or Netflix. The blunt truth is that companies in the US fail more quickly as lenders and investors require higher returns. The absence of a genuine cost of capital has dogged Japan’s recovery too. High numbers of limping zombies or “losers” can seriously damage the efficiency of capitalism and overall market performance.

For private investors perhaps the key message would be that Europe has plenty of world-class investment opportunities but is also carrying a lot of baggage. For equity crowdfunding investors bear in mind that little statistical nugget about how a relatively small number of winners deliver the majority of wealth creation. There is plenty of merit in a strategy to build a portfolio of start-up investments to boost one’s risk exposure. And remember, even in the big blue-chip markets there are lots of failure zombies too. The US markets have found a few winners in recent years but there’s no reason you can’t find a few too over the next decade.

 

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