Investors should back the US over the long term as it has better companies, a more stable political and financial environment and is not burdened by the “straightjacket” of the euro, according to Hargreave Hale’s Andrew Moffat.
Europe has been a popular investment this year, with many investors reallocating capital from the US to the eurozone.
This has partly been due to improving economic numbers from the region, with most data points continuing to show a recovery in the domestic European economy.
Last month’s purchasing managers' index (PMI) data, for example, came in at 57.4 versus 56.6 in July while in some countries such as Italy and Greece the readings were at six- and nine-year highs.
The MSCI Europe ex UK index is ahead of the S&P 500 by 69 basis points so far in 2017, though this has narrowed significantly in recent months.
Performance of indices over YTD
Source: FE Analytics
However, despite the strong run this year, Hargreave Hale’s Moffat, who co-manages the £56m Marlborough Extra Income fund, said there are underlying factors that make it a risky proposition for investors over the long term.
“I have heard this story before on Europe many times and many times it has ended in disappointment and I think there are some solid reasons why the disappointment tends to come through over the long term,” he said.
The first issue is the ongoing problem of the euro, which he said is a “straightjacket” for certain countries within the European economy.
“I think Europe does suffer from the single currency over the longer term still. The fact that it can’t mutualise debt and it can’t create this federal state which it clearly would like to over the long term is a constraint. The single currency is a slight straightjacket,” the manager noted.
“I accept that it probably pays longer term for countries such as Italy not to continuously try to depreciate themselves to prosperity by lowering the level of the Italian lira historically because they don’t want to undertake reform.
“But I just think in an economy with such different structures and such different productivity rates the single currency has confined a lot of countries in terms of their ability for longer-term growth.”
The manager added: “There is obviously political momentum behind the single currency going forward but I just think it is probably a failed experiment that will keep on going and I think that is a big negative for me on Europe longer term.”
This is in stark contrast to the US, where there is more cohesion at the federal level and ‘one size fits all’ in terms of interest rate policy and currency movements.
The second long-term point is that when it comes to governing, Moffat said the US is much more forward looking than some members of the eurozone. 
“I think Europe suffers from the austerity of Germany and the fact that there is a big savings ratio there,” he noted.
As well as this, anecdotal evidence also backs up this point; for example defence spend which is still historically low within Europe and that there seems to be little in the way of longer term aspirations to raise internal consumer spend within the key economies in Europe, Moffat (pictured) added.
“I think the model of economic activity within the US is stronger longer term than Europe and that is why the US outperforms Europe,” he said.
“There is a little bit of short-term cyclicality currently and Europe is generating better growth in certain regions but I am talking specifically over a longer period of time.”
Another reason Europe historically underperforms the US is the number of legacy companies – those that are still in the old economy that make up a large weighting of the index.
He highlighted that there are large-cap companies that are still capex-long, heavyweight industries while some of the exporters are dependent on currency weakness to perform longer term.
“I think it still has that dependence on a softer currency and I expect when the currency goes up, as it has done over the last couple of months, then economic momentum will just fade as Europe is quite a cyclical region,” Moffat added.
Meanwhile, there is also a lot of political control in Europe with countries like Total in France and EMI in Italy closely monitored and regulated by the government, he noted.
“I think the US does have some legacy companies such as General Electric but just less so than Europe,” the manager added.
“And obviously the US it is in the vanguard of global leadership in 21st century business models, which is technology, and I think the pricing power is stronger and certain corporations are becoming stronger in terms of oligopolies.
“The advancement of the digital economies is far more advanced than in Europe. There are a lot of excellent asset light business like Visa and Paypal and Facebook where valuation is a question mark but the return on capital is very strong.”
Turning more specifically to this year, one of the reasons investors have grown more positive is the improving political situation, with Emmanuel Macron winning the French election seen as particularly important.
Meanwhile, the election of Donald Trump in the US has cast a doubt over the political stability in the country, but Moffat said investors need not worry.
“The Trump situation – we all know what that is – but I think the interesting thing is that America is the most capitalist system imaginable and I think it is better for the US stockmarket that there is gridlock,” he said.
“It always tends to be the case that the American stock market does badly when one party dominates the Senate and the House of Representatives.
“Obviously the Republicans have got the power of all three keys at the moment but they are just not affecting policy and I think as long as there is less intervention then US companies can do quite well.
“So the fact that Trump can’t get anything through and can’t repeal Obamacare and get his tax reforms through is good for private companies.”
The other reason investors have grown more confident on Europe this year is the valuation bias that the region has having underperformed the US for much of the last decade, as the below chart shows.
Performance of indices over 10yrs
Source: FE Analytics
“On valuation, the US always trades at a premium to Europe. I don’t think that is a reason to underweight the US in relation to Europe,” Moffat said.
“The S&P 500 has performed extremely well and I am not expecting that rate of growth to continue but America trades on 18 times forward earnings for 2018 which is about mid-cycle,” he added.
“Europe trades on 14-15 times forward which is obviously a discount but that wouldn’t be good enough for me to go and buy Europe.”
The manager noted that he is not a value investor, rather looking for growth at a reasonable price by focusing on the underlying fundamentals and quality of companies and countries.
Another criticism of the US is that a narrow number of stocks have delivered market returns but Moffat said this is normal during bull markets.
While valuations of some of those stocks are high, and have been for four or five years, they have very strong business models and as such cannot be compared to other peers, he said.
Overall, the manager said he would begin to take a more positive stance on Europe, despite its flaws, if there were an uptick in anecdotal information, such as German government looking to raise defence expenditure or implement stimulus to boost consumer demand.
Another positive would be and uptick in technological advancement and company research and development expenditure picking up – something the US is has been particularly good at in recent years.
He said: “We are in a period where we are going to see a very elongated business cycle but I think the disruptive technologies and pricing power and polarisation of businesses will come to the fore.
“This will be more detrimental in Europe thanks to the spend on technology in the States in compared to Europe.”