There is another new taunt in the “yah boo sucks” slanging match between the City of London and Wall Street. The value of European stock markets has eclipsed that of the US.
The moment slipped past unnoticed last Thursday, but make no mistake, it was a historic occasion. Totting up the value of all the companies on the 24 stock markets of Europe, from west to east and taking in Russia and Turkey, you get $15.73 trillion. That’s a nudge ahead of the total of US-listed companies, and you probably can’t have said that since the end of the First World War.
Now that the news is out there, it has immediately been pitched into the argument over whether New York is in danger of losing its position as the financial capital of the world. For London, it is another piece of evidence to back the Stock Exchange’s boasts that it is attracting foreign companies that would previously have looked to list in the US. And for some Wall Streeters, it adds new urgency to their calls for looser regulation and other measures to win back lost business.
It is an important piece of evidence in that debate, for sure, and there is no doubt that the London listings of Kazakhstani copper miners and Chinese phone manufacturers have contributed to Europe’s swelling market capitalisation. But there are bigger reasons for the shift and wider lessons to be learned.
For the record, the figures come from Thomson Datastream, not the traditional calculators of indices, such as FTSE or MSCI. These others strip out government holdings and other shares that are not generally available to investors, which lowers the value of European markets, which include many partly privatised companies and the like.
The first reaction of many on Wall Street yesterday was to dismiss the figures as a distortion or an irrelevance. Russia shouldn’t be included as part of Europe, some said. Others asked, what is the point of a comparison with a geographical area that covers two and a half times as many people as the US? And still more said that FTSE and MSCI figures better reflected the size of the equity market available to investors, where the US still wins by anything from 15 per cent to a third. Fair points all, but none diminish the significance of the underlying trend identified in the Thomson figures.
A number of factors have combined to push Europe into pole position: overseas acquisitions by European companies; the declining value of the dollar; the emergence of Russia and other former Communist states as economic powerhouses. And one other factor, too – European companies have made more profits for their investors in the past few years than US companies.
Ian Harnett, the independent analyst who spotted that Europe had overtaken the US and alerted his clients on Monday, said investors have rewarded con-tinental European companies for painful restructurings that have improved their returns on equity (their profits relative to the book value of the company).
“The change in relative ranking of Europe and the US also reflects underlying improvement in the fundamentals for European companies relative to those in the US. In early 2004 both European and US returns on equity averaged 12 per cent, but the average return on equity for quoted Europe is now above that in the US – something almost unimaginable in the mid-1990s.”
It is this that lies behind the spurt put on by European markets over the past four years. The declining value of the dollar against the euro may have accounted for about 20 per cent of the gain over that period, but not a majority. Even stripping out emerging markets – including Russia, whose equity market has quadrupled in value – would reduce the gain by about 9 per cent, Mr Hartnett suggests.
The question Mr Hartnett left his clients to chew over was whether the new order was a temporary phenomenon, and since he is pessimistic on the outlook for emerging markets in a more risk-averse environment, he is not so sure.
Khuram Chaudhry, head of pan-European quantitative strategy at Merrill Lynch, also suggested that some of the gain has a cyclical quality to it, particularly since the best performing market, Germany, is a big exporter.
“You have an environment where US assets have been underperforming European and Asian assets in recent years. The US is perceived as having higher quality ‘blue chip’ companies, not necessarily growth companies,” he said, adding that US assets may outperform in an economic downturn that prompts an investor “flight to quality”.
But Mr Chaudhry added that longer-term trends bolster the sustainability of Europe’s lead. “European companies have been active buying US companies, more so than the other way round. For example, BP, the British oil giant, bought Amoco and Arco in the US, and these companies now come under the European listed umbrella.”
Whatever the reasons for the reversal of position, it is difficult not to interpret such a seismic shift as a humiliation of sorts for New York. It comes just a week after a survey showed that finance industry salaries can be up to 50 per cent higher in London, sparking consternation on Wall Street. The European financial industry is also fast approaching that of the US in size, with investment-banking revenue of $98bn last year, compared with $109bn in the US.
The latest news was immediately seized upon by those who argue that Wall Street is being strangled by red tape, and who have campaigned for a watering down of Sarbanes-Oxley (the anti-fraud laws introduced after the collapse of the energy company Enron in 2001). Wayne Brough, chief economist at the free market think tank Freedomworks, described the news as “a shot across the bows” for the American economy.
“We do have deep capital markets, we do have a vibrant economy, but we have been sitting on our laurels thinking we are a country where people would invest. Now we have to start competing, and we have to look at the climate we are creating here. As well as regulation, you have litigation concerns you don’t see in other countries, and our tax code is getting a little behind the times.”
Fears that New York’s status as the world’s financial capital is eroding have prompted a rash of reports, conferences and policy discussions among the political and financial elite. A consensus has emerged that the implementation of Sarbanes-Oxley should be relaxed, but it is unclear as yet what other actions might be proposed to claw back market share for New York.
Leading the efforts are the city’s mayor, Michael Bloomberg, founder of the Bloomberg financial news empire, and the Bush administration’s Treasury secretary, the former Goldman Sachs boss Hank Paulson. They do cite London as the first-order threat to New York, but they recognise a much bigger long-term issue, and one which is lurking in the Thomson figures. Europe and the US are tied on a 35.3 per cent share of the value of all global stock markets, the figures show, but that combined 71 per cent compares to more than 80 per cent a generation ago.
That means that big new companies and vast liquid stock markets in India and China have been gaining ground. The see-saw between Europe and the US might ultimately prove less important than what is going on in Asia.
Mr Chaudhry summed up the bigger picture. “The world is changing. The US has been the dominant power, but we are going through an empire change.”