Credit risk in today’s fixed income environment
January 9, 2019
American Funds video transcript: “Why European markets have lagged the U.S.”
Matt Miller: Let's start with international and emerging markets. The equities there have been a hard sell in recent years as the U.S. has outpaced the world ever since the global financial crisis. How would you explain the reasons for this disparity between U.S. and global and emerging market performance?
David Polak: A lot of the disparity really goes back, as you mentioned, to the financial crisis. And we're coming up for the 10th anniversary of when the world markets bottomed, in March of 2009. And back then, it was really apparent that growth — cyclical growth — was going to be in short supply.
So, our analysts and portfolio managers began to look around the world for companies that could grow, not just by themselves, but had a large say in how they grew — what we might call secular growth. In other words, they were authors of their own future to a larger degree than just relying on the economy. And over the past 10 years, companies in the internet, companies in biotechnology, companies in new media and a lot of the companies that make the tools that allow those internet platforms to be created — those have done well. Secular growth has done well. So, in the United States, we've seen the issue of growth outpacing value.
When you look at the world through that lens, what you notice is a lot companies that innovate, disrupt, have imagination are in the United States. There aren't many in Europe. For instance, in the S&P 500, technology is over 20% of the index, and that doesn't include consumer discretionary companies like Amazon and Netflix that are also disruptors. In Europe only 5% of the index is in technology companies. That 5% makes up about $500 billion, which is half the market capitalization of Apple.
Matt Miller: And that's a striking comparison. And striking statistics.
David Polak: Sometimes in a conference it's kind of fun to say, "Hands up, anybody who could name a European technology company." It brings the point home. And a few hands go up and say, "SAP." Nobody ever talks about ASML, a Dutch company that makes semiconductor equipment. Those two are half of that 5%, half of that $500 billion.
So, part of the issue around Europe, for instance, lagging the United States is to do with some of the poorer politics and economics, and that's where a lot of people go. But as a bottom-up investor at Capital, what we've found is that we've gravitated over the last 10 years to this new economy, these disruptive companies, and they tend to be in the United States or in Asia — in places like Taiwan, China, Korea — not so much in Europe.
Matt Miller: Let's focus on Europe for a moment. After a strong 2017, growth is tepid and equity markets are lagging. To what degree is political uncertainty, as you hinted at — is that to blame? Or what are the other factors that you would say are driving that?
David Polak: Political uncertainty affects the investment decisions of companies, so that is a bit of a lag. Also, I think we need to go back to 2009 and look at the response in the United States to what was a credit crisis, and the steps that were taken to shore up the U.S. financial system. Partly because of the political situation in Europe, those steps weren't taken with European banks. And so they are much weaker and have smaller markets and, therefore, are less able to deal with some of the issues they face. And those issues are also then impacted by politics, which leads to lower growth, higher unemployment without credit growth is an issue.
And also — again, back to 2009 — what the central banks around the world began to do was lower rates, buy bonds. That's not good for banks, because you don't have much of a yield curve. In other words, banks borrow short, lend long; they can take a spread between the short- and the long-term money. When you haven't got much of a curve — and with rates so low because of tepid European economic performance — the banks aren't going to do well. Banks are a very large part of the European index, the European opportunity set.
Matt Miller: Right.
David Polak: And again, you come back to this juxtaposition of, in the United States and Asia, you have more opportunity; you have more new-economy companies, more secular growth. In Europe, you have companies that are impacted more by cyclical growth — and the growth just ain't there. And part of that's due to the politics, yes.
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