Hot Stoxx summer

0:08Ian Smith: We've been in earnings season when companies that are listed on the stock markets tell the world how they're performing and give us a sense of what lies ahead. US earnings have been pretty spectacular, helping the US stock market to crack out some record highs after a pretty long period of dawdling around going nowhere. So, American exceptionalism, baby, back in the game. Go, go, go, all fuelled by the miracle that is big tech and the AI trade. OK, fine. But quietly, you know what? Europe is having a great run. It's comfortably keeping pace with the US stock market performance, despite the lack of tech superpowers and the lack of that chest-thumping bravado that we get from our noisy American friends.

0:55Ian Smith: Again, hi Rob, hope you're enjoying your holiday. Today on the show, we mean at this time, make Europe great again. This is Unhedged, the markets and finance podcast from the Financial Times. I'm Pushkin. I'm Katie Martin, a markets columnist at the FT on the planet Mercury. I mean, in London, same temperature. Joining me down in the bunker of FT Towers is my right-hand man, the guy who does the hard work on the actual markets news here at the FT, Ian Smith. Yes. Ian, thanks for coming back on. Thanks for having me back. So, yeah, I mean, these Americans, they eat up a lot of kind of global brain space, don't they?

1:35Ian Smith: Everyone's talking about how amazing the American earnings season has been, how much money all these companies are making, how great the stock market is. Let's just settle slightly on that. That is a thing, isn't it? They've been doing brilliantly. They have been doing brilliantly. And even if you strip out the massive gains they get from the equity investments they have in tech themselves, which inflate their earnings, they are still doing amazingly. Yeah, these companies are making serious money and more money than the analysts have been expecting. Yeah, they've had a really good second quarter earnings season, earnings per share growth around 30%.

2:08And that's if you exclude those equity investments like the other income from those that I mentioned. And it's been something that has fed broader market stability. and it has fed this AI narrative, which is really just the leviathan in global markets in terms of a dominant narrative.

2:25Ian Smith: Yes, so in US markets, we've had this kind of weird period where there's been a lot of churn under the surface, right? Kind of hyperscaler stocks, like companies that consume a lot of these AI services and invest a lot in AI stuff. They did really well. Then they sort of fell out of favour and it was the chip stocks that were doing really well and they were kind of battling against each other almost. But on an index level, the US market just sort of didn't really go anywhere for about six weeks. But earnings season does seem to have, you know, added that little bit of bababoom and helped the market go to new highs.

2:59You have seen times where people have focused on the cash outflows from some of these groups and worry about that and the sustainability of the spending by the hyperscalers. But earnings has been really robust. And that's the thing that sets it apart from, say, dot-com and previous market speculative bubbles, is that there are real earnings, there's real revenue being made.

3:21Ian Smith: Yeah, yeah, they're making some serious cash. But the US is not the only game in town, right? So I was talking to a chap called Vincenzo Vedder, who's the chief investment officer at DWS the other day. And he was saying that they run sessions in Asia for investors called Gateway to Europe. and they explain to investors over there, this is how Europe works, this is what the EU is, so this is what the European Union is, this is how the member states work, this is the difference between the two, like a real kind of ABC of Europe education programme for investors out in Asia because they haven't touched European stocks for so long, some of them.

4:03Ian Smith: You know, it doesn't make them stupid people, it just makes them perfectly rational investors that have been like almost no earnings growth out of Europe for a really long time. So they've just like ignored Europe. And now all of a sudden they want to have a little bite at it again. And they're interested in finding out more. And I think it's interesting that there's appetite for those sorts of let's find out about Europe educational sessions. But it's also like, oh boy, like something has gone really wrong here that people have kind of forgotten that Europe exists as an investment destination.

4:35I don't know.

4:36Ian Smith: There's just there's a lot of work to do to get people to realize it's there. Yeah, it has long been the poor relation to the US. It's much more flashier cousin. European stock markets have partly because they just haven't moved with the times. You know, if you look at the top of the UK stock market, the biggest companies, it's the same companies that were the biggest one a few decades ago. It's kind of commodities, banks, pharmaceuticals. If you look at the US, it's gone from being kind of the conglomerates of old to the tech of today, right? It's like their stock market has moved with the times, ours haven't.

5:08but still there is a good story to tell that is really going underappreciated at the moment in Europe you know there's a few good reasons for that earnings have been strong yeah and flows have been good and performance has been good and we can talk about those well yeah so performance

5:22Ian Smith: right so so far this year the S &P 500 which is like the benchmark US stock index it's up 13 % so far this year good okay fine but the FTSE 100 you know this sort of Mr Bean kind of stock market that people like to be mean to and don't pay very much attention to and think it's ridiculous. It's up 9%. That's pretty good. The FTSE is at a record high or close enough. The stock 600, big sort of pan-European index, that's up almost as much as the S &P. That's up 11%. And if you look at some of the individual countries, Italy is up 20 % this year. Spain is up 17%. And it's still like weirdly fighting for attention.

6:04Ian Smith: It is odd, isn't it? But there are a lot of reasons to like it. There are. And I think even if you look on a slightly longer time frame from the start of last year, and we've talked about this on the podcast before, but if you look in fixed currency terms and say, like, in euro terms, how have European stock markets done versus the US? They've kind of trounced the S &P since the start of last year. So there really has been a performance story in European equities that we haven't had for a long time. On top of that, we're getting some momentum back in earnings too. There was a very good Goldman Sachs note on this from Sharon Bell this week, where she dug into this kind of first half earnings per share growth of 14 % for the stock 600, which is the big European benchmark index, which is the best year or putting it in your best start to the year since 2022.

6:52Flows have been good into European stocks, people passing through that gateway from Asia and elsewhere, and kind of putting it on track for one of its kind of best years in the decade in terms of flow. So there really are some of the components that are massively overshadowed by this big moon of AI, which is blotting out the sun of attention. This is a tenuous, very tenuous reference to this week's solar eclipse.

7:15Ian Smith: Yeah, so people are all kind of, you know, drawn to US markets like kind of moths to a flame. Oh, it's so shiny. It's got so much shiny technology. We must own this thing. But actually, one of the things that a lot of investors have talked to me about recently is, look, we love the US tech story. We're invested in it. We intend to continue to be invested in it. But we want a bit of diversification. We want markets that do other things either as well or instead. So actually, the fact that UK and European markets don't have that much AI in them, don't have that many sort of chip stocks in them, that's actually weirdly a benefit.

7:55And that is where the flows have come into. You've seen defence do well, to your point before, you've seen banks do well as kind of steeper government yield curves, which have created a more profitable environment for banks. So like banks have done well in Europe. Yeah, defence has done well with greater spending and focus on that sector for reasons we all know about. I think the challenge is that you've seen diversification flows into those areas where people are clear that there's an investment case, but it's the other bits of Europe that need to kind of attract investment. Right now, do you go into consumer cyclicals and other sectors in Europe at a time where there's still the Iran war threat to growth?

8:33and if there is some kind of AI blow up that disturbs global growth is that the right place to hide you know some of those more cyclical areas of the European stock market as an investor put it to me earlier so I think it's that challenge you know it's telling the story but it's also having the sectors that people want to diversify into but there's also this very big impetus which is that US stock valuations are getting up to quite high levels yeah dividend yield in the US kind of reaching real lows close to 1 % on the S &P 500, which is really like you're not getting much reward for buying fresh in the US right now.

9:06Ian Smith: Yeah, yeah. So European stocks are cheap compared to US stocks now. You can argue they're cheap for a reason and fine. You do get much higher dividends in Europe than you do in the US. So dividends, like if you buy a stock as an investor, you get a little check in the post every year or every quarter from the company saying, thanks very much for holding on to this stock. Here's a little something to, you know, don't spend it all in the one shot, but here's a little something to keep you sweet. And most people just churn that into more investment. Yeah, you referred to that very nice note from Sharon Bell at Goldman Sachs about myths about investing in Europe.

9:41Ian Smith: Myth Europe. Anyway, she was pointing out that since 2022, European banks have considerably outperformed the Magnificent Seven. It's not even close. Like it's a massive outperformance. Now, European stocks, think back like a decade or 15 years, you would need your head examined if you were buying. It would have worked out very well long term, but that sector was in such horrible shape that it got really beaten up and no one wanted to touch it with a barge pole. As you say, because of the way that long term borrowing costs have been panning out, European banks have been doing fantastically well.

10:15You know, that's a sector also that was trading really a discount to its book value for a long time, a sizable one because of some of the regulatory fines and other things that stem from the financial crisis and other scandals. So there is a bit of a sectoral thing happening there too.

10:28Ian Smith: So, you know, what else is to like about Europe? It doesn't have the big shiny tech thing, but what does it have that's a positive apart from just not being the States? it has got a big energy sector that's been a substantial factor in the earnings growth that we've seen but if this iran war has showed us anything it's the value of commodities and like the strength of the in commodity sector we've mentioned banks we've got pharmaceuticals we've got other kind of strengths in the equity market that do offer that diversifier from american tech and you know we have a couple of tech groups too um you know just to round out the picture Yeah, exactly.

11:05Ian Smith: But yeah, there's this idea that what we've seen with energy prices so far this year, you know, as regular listeners to this podcast will be well aware that has been a ride thanks to what's going on in Iran. But to be clear, it is bad news for Europe in a lot of ways. But again, you've got to remember, markets are not the economy. And, you know, markets are not household budgets, like these things are different. And actually, when you look under the surface of European stock markets, there's a lot of stocks in there that benefit from these higher energy prices. Yes. And does it feel like energy security is going away as a real imperative for big economies?

11:41No. I'm like there are stocks in Europe that will benefit from that.

11:44Ian Smith: Yeah. Yeah. And loads also loads of companies that are working hard to do green energy, which I think anyone with a brain can see this is a sensible time to do that. And defence, a sector that often people can get squeamish about, but especially in the UK, it's a significant sector. And given like the amount of kind of conflicts in the world and the desire of governments of all types to spend more on defence, you know, there are definitely sectors that benefit from some of the prevailing trends. Yeah, 100%. So there are lots of reasons to like Europe. It's performing well. You cannot argue with the market performance.

12:18Ian Smith: There is this idea that people have, well, you can't buy European stocks because everything that Europe does well is about to get chewed up and spat out by China. And that's kind of not really true. Like the auto sector, sure, we've got a problem there. But this idea that the entire German economy is a couple of car companies is just like rubbish. Yeah, it's reductive. I mean, there are sectors in Europe that shouldn't be, you know, so unloved as they are. But I think there are still some of these threats in the background, the Middle East war being won, Europe as a kind of energy importer being very susceptible to that.

12:55Also, you know, some of the pressures from higher government borrowing costs affect Europe. If there is going to be more inflation driven either by tariffs or energy prices, you know, some big European economies like France, like Italy and like the UK could be put under pressure on the fiscal side of things as well. So there are a lot of elections next year that will kind of throw up political risks. So I think there are things that cloud the waters. I think the other thing that people focused on at the moment is that how much of the growth in Europe is just being driven by Germany and extra German spending.

13:29And do we need more of the reforms such as were laid out in the Draghi report to kind of attract more capital into Europe?

13:36Ian Smith: Well, that's the thing, isn't it? So Mario Draghi, who used to be the president of the European Central Bank, was it about 18 months ago now, put out a big report about how European markets are just like a bit, they didn't have the same kind of va-va-voom as US markets. And he sort of laid out a bunch of reforms that were needed to kind of fire this up. And one thing that still hasn't really happened as a result of him articulating this is that like Europeans just don't invest in stocks in the same way that Americans do. So I'm tap dancing here, but I think the number is about two trillion euros that's just sitting in deposits in Europe doing absolutely nothing, just sitting in bank accounts, gathering dust, not even getting that much interest on it.

14:21Ian Smith: And everyone in Europe is like wringing their hands saying, how the hell do we get this money out of people's bank accounts and have them put it at the very least into the bond market, but ideally into the stock market? You know, it's a huge kind of potential injection of money. And it's proving really hard to convince, you know, stereotypically quite risk averse European investors, you know, including British investors to do that. And that's really hard. And this is something that comes up when you talk to bigger institutional investors about, you know, what are the longer term changes you could see in Europe that would lead you to allocate more of your money there?

14:59They come back to you. There's a lot of different government bond markets. And like, is there a common asset? Something we've talked about a lot before, you know, on the stock market side, given like, there's this huge retail bid in the US, but in Europe, like a lot of that money is tied up in savings. are there going to be any of the savings and investment unions that will kind of catalyse kind of the markets and lead people to want to put their money to work here like i think these things do come up again and there's not been a huge amount of progress on some of that yeah compared to some of the hopes we were talking about last year yeah but generally i'm hearing

15:32Ian Smith: a pretty optimistic tone about europe i don't think people think that what we've seen so far this year is a blip i think something has structurally changed i think that europe has seen as you know it's got diversification benefits it's you know frankly it's just not america but yeah if you're talking to an investor if you're listening to this and you're talking to investors in asia or or even in the states or whatever don't assume that they know what we're talking about like europe has done a phenomenally bad job at talking its own book i think over the past 15 years so we should lay it out for people now so british people we're the ones with the bad teeth and strange regional accents.

16:10French people have nice food.

16:11Ian Smith: Yeah. It's getting very hot there. Yeah. Italy, occasional debt market wobbles, but some incredible architecture and history. Yeah, but it's just not that bad of a place to put your money to work in. You know, we're not just here for the tourism. People make it happen. We're going to be back in just one sec with Longshore.

16:37Ian Smith: Okie doke, it is time for long, short, that part of the show where we go long a thing we love or short a thing we hate. Ian Smith, hardest working man of the FT, what are you saying? That's really not true, but it's very kind of you to say. I'm going to go long implied volatility in stocks, currencies. It's so clever, listeners. No, but it's potentially very stupid because it's been a terrible bet. Volatility just keeps falling. Markets come back from every single shock. They're so calm. They're so calm. They're annoyingly calm for a reporter. But I just think with the degree of elections we've got coming in Europe, we've got a UK budget that should be kind of interesting.

17:15We've got the yen, we've got US stocks like bumping against interesting valuations and occasional blow-ups, and we've got potentially rising interest rates. I think it's a good environment for a bit of vol, no?

17:27Ian Smith: A bit of volatility. I am long Wetherspoons. the British pub chain has about 800 pubs it's run by a guy called Tim Martin who is not my dad a rumor that Rob Armstrong started a few years ago anyway Wetherspoons is at the forefront of the backlash against those awful awful smart glasses that I hate so much those pervert glasses the ones with the cameras in them I'm aware of the glasses I'm aware of your position but what's the Wetherspoons like so so Wetherspoons kind of banned the glasses you can still wear the glasses in the pubs but they've made it clear that you are not to go around filming like surreptitiously filming staff or customers or or anyone else oh good for them pint glasses over smart glasses yeah where i spent a lot of my youth in a tunbridge world of spoons i once queued to get into one which is oh that's appalling i know this was what you had to do when you were a really cool when you're a cool guy at ageing to get into spoons but like you know i hate these perfect glasses anyway as i've made very clear but like women should be able to go to the pub without being secretly recorded after they've had that deadly fourth glass of Pinot Grigio.

18:37Ian Smith: But anyway, I commend Weatherspoons on this position. Why do they have to record? That's the thing I don't get with the glasses. Ian, don't get me started on this. We don't have time for me to list the many reasons why I hate pervert glasses, but I hate them. Listeners, we will be back again on Tuesday, so please do another little rain dance and listen up then. Unhedged is produced by Trina Menino and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Special thanks to Laura Clark, Greta Cohn and Natalie Sadler. Flo Phillips is the FT's global head of audio.

19:17Ian Smith: FT Premium subscribers can get the Unhedged newsletter for free and a 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.