From Verdad Advisers, April 3:
Viva La Revolución!
“Long live the revolution!” might be the rallying cry of today’s Silicon Valley investors, but the real rise of the proletariat may be occurring in Europe.
The last decade witnessed a technological revolution as cloud computing and smart phones became widely adopted. Amazon Web Services was launched in 2006, the iPhone in 2007, and the App Store in 2008, forming the crucial foundations for what was to come in the 2010s. The COVID lockdowns and the shift to working from home cemented the rapid share gains of cloud and mobile technologies.
Investors who bet on these novel technologies earned extraordinary profits. During the ten years ended Dec 31, 2021, the tech-heavy Nasdaq index compounded at an annualized rate of 21% per year, far outpacing other developed markets like the 9% annualized return in Europe, where the market primarily comprises “old economy” sectors like food, industrials, energy, and financial services.
At the beginning of 2022, it appeared the technology revolution was poised to gather more strength as old economy sectors were hobbled by supply-chain snarls while software continued to flow freely above it all across the cloud. Moreover, Eastern Europe became embroiled in the largest land war since World War II while most of the leading technology companies are based 10,000 kilometers away from the front lines.
But the last few quarters have seen a major reversal of these trends—a shocking reversal, given the bullish expectations for technology and the geopolitical concerns about Europe. Over the course of 2022, European firms grew their earnings at a faster rate than the tech-heavy Nasdaq, with 20% EBIT growth in the European market versus 5% growth in the Nasdaq. And despite the spiraling cost inflation that was triggered by the reconfiguration of natural gas supplies, the European market had relatively stable EBIT margins in 2022 versus 2021, with only 30bps of compression between the two years. Meanwhile, EBIT margins compressed by 100bps in the Nasdaq over the course of 2022.
Figure 1: EBIT Growth and Margins (2022 vs. 2021)
Sources: Capital IQ, Vanguard (“VGK” for FTSE Europe Market ETF), and Fidelity (“ONEQ” for Nasdaq ETF)
These surprise outcomes are reflected in the recent returns of the Nasdaq and the European market since the beginning of 2022. As rising interest rates have deflated asset prices across the board, the expensive Nasdaq has dropped by 20% whereas the European market has fared relatively better with a 7% drop, as shown in the figure below
Figure 2: Value of $100 Invested in Nasdaq and Europe Market (Jan 2022 – Mar 2023
Sources: Capital IQ, Vanguard (“VGK” for FTSE Europe Market ETF), and Fidelity (“ONEQ” for Nasdaq ETF)
To be sure, the recent reversal in tech leadership is a notable departure from the past cycle in market history....
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