Three midweek thoughts — 'magnificent' banks, Japan switch, populism: Mike Dolan

This week's market headlines have been dominated by Gulf tensions, inflation, bond market angst and the latest White House attack on Federal Reserve Governor Lisa Cook. But strategists looking beyond the noise are focusing on other developments: Europe's unexpected outperformers, Japan's preference for euro debt and International Monetary Fund (IMF) musings on populism. You don't have to look far to see a gloomy investment narrative about Europe's economy and investment performance — at least compared with Wall Street and its shiny new AI attractions. That worry list is well worn — energy exposure, defence pressures and budget worries, Chinese competition and the lack of a tech sector to rival the U.S. or China. Some of these problems are real, while others are imagined, at least on a relative basis. Goldman Sachs strategists this week took a stab at busting myths underpinning negative views of European equities, highlighting projected double-digit earnings growth this year and brisk portfolio flows into continental shares. But in doing so, their most eye-catching observation was that boring old euro zone bank stocks have substantially outperformed the U.S. "Magnificent Seven" megacap tech giants since early 2023, before the moniker for the Wall Street high-flyers was even coined. A check of the figures shows that since the launch of the Roundhill "Magnificent Seven" exchange-traded fund MAGS.O — which tracks Microsoft MSFT.O, Meta META.O, Nvidia NVDA.O, Apple AAPL.O, Alphabet GOOGL.O, Amazon AMZN.O and Tesla TSLA.O, in April 2023 — it has risen 182%. However, the main euro zone bank stock index .SX7E is up almost 210% over the same period, driven less by AI than by the return of durably positive interest rates in the region for the first time in over a decade. Throw in a currency effect and the dollar-terms gain for a notional Boston-based investor in the main euro zone banks index has been 225%. Ladies and gentlemen, Europe's own "Magnificent Seven" bank stocks include UniCredit CRDI.MI, which has risen 361%; Santander SAN.MC and BBVA BBVA.MC, up about 280% each; ING INGA.AS and Intesa Sanpaolo ISP.MI, with gains of about 185% each; BNP Paribas BNPP.PA, which has doubled; and Nordea NDAFI.HE, up 73%. If right-wing and left-wing populism are on the rise in politics, inflation watchers and central banks should beware. An IMF working paper this month studied developed and emerging economies since 1960 and found that waves of populism — historically mostly from the left — were linked to marked increases in central bank lending to the central government, deficit monetization and rising inflation. "Importantly, the impacts of populist regimes can outlive the regime’s lifespan," the authors concluded, pointing out that correcting for the mistakes of these periods typically led to a need to overcompensate with more independent central banks, stricter monetary policy and greater sensitivity to any shift in inflation expectations. "Central banks operating under the shadow of past populist regimes that relied on deficit monetization need to send stronger signals of their independence and commitment to price stability to effectively anchor inflation expectations and contain inflationary pressures," the paper found. What constitutes populism per se, of course, is a whole other matter for debate these days. What's clear, however, is that it can come from both sides of the political spectrum. Perhaps the most significant takeaway is how many of the examples from Latin America and around the developing world were episodes that largely happened in a world more anchored at the centre. How populism at the core pans out for the globe at large is much harder to see from studying the past. Just as everyone pored over the whys and wherefores of the recent joint U.S.-Japan intervention to lift the ailing yen JPY=, it transpires that Japanese investors have been switching back to European sovereign bonds in droves this summer — most notably Britain's gilts 0#GBTSY= and France's OATs 0#FRTSY=. Official data for June released this week showed that Japanese investors reduced their holdings of U.S. Treasuries by $5.6 billion while adding $2.2 billion to French government debt, $1.5 billion to UK bonds and $1.2 billion to Italian sovereign paper. "The stabilisation in U.S. yields appears to have encouraged some diversification away from Treasuries and towards European sovereign debt," noted Mizuho strategist Masayuki Nakajima. Societe Generale's Stephen Spratt pointed out that this represented a significant return to the French debt market after several months of net Japanese sales, while buying of gilts in June was the largest since last October. Attractive spreads were likely the magnet, he said. To be sure, the one-month flows are not seismic, and Japanese investors have historically held significant amounts of British and French debt. Foreign investors own one-third of Britain's gilt market, and about a third of that is held by Japanese creditors. But the timing of the gilt purchase was notable, coming in the month that Keir Starmer stepped down as Britain's prime minister and Andy Burnham began the process of succeeding him. The French purchases are also noteworthy given looming political and budgetary issues in Paris. Most striking was the switch away from Treasuries even as the dollar surged to 40-year highs against the yen.

Three midweek thoughts — 'magnificent' banks, Japan switch, populism: Mike Dolan

Europe's banks outperform the U.S. megacaps

IMF research links populism with inflation pressures

Japanese investors rotate toward European sovereign debt

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