Investing in the European market has long been considered a way to diversify a portfolio and reduce risk. However, whether investing in the European market provides diversification benefits for US investors is largely dependent on the correlation between the US market and the European market.
Correlation Matrix: US vs European Market
Correlation is a statistical measure that represents the degree of association between two variables. When it comes to investing, correlation is used to measure how closely the performance of two or more investments or markets are related.
Historically, the US and European markets have had a positive correlation, meaning that they tend to move in the same direction. This is due to several factors, including global economic trends, political events, and trade relationships. As the world’s two largest economies, their performance is heavily intertwined. For example, changes in the US economy can impact the demand for European goods and services, which can, in turn, impact the performance of European companies and markets.
However, the correlation between the US and European markets is not always positive. In some instances, the markets may move in opposite directions due to regional economic or political events. For example, political instability in Europe may cause investors to shift their investments to the US, causing a decline in the European market while boosting the US market.
Performance of the European Market in the previous year
The European market has been known to be volatile and affected by macroeconomic events. Despite this, over the last few years, the performance of the European market has been relatively strong. In 2020, the European market experienced a rebound after the initial impact of the COVID-19 pandemic. Additionally, the market has been supported by the European Central Bank’s accommodative monetary policy and government fiscal stimulus.
The outperformance of the European market over the US market has been significant in the last year. The MSCI Europe Index has returned over 42% over the past 12 months, while the S&P 500 Index has returned around 30%. One reason for this outperformance is the more significant growth potential in the European market compared to the US market. This potential is due to European countries being at an earlier stage of the economic recovery from the pandemic than the US. The European Union’s stimulus package is also a contributing factor to the growth potential & undervalued assets of the European market.
Investing in the European Market
Investing in the European market may provide diversification benefits for US investors seeking to diversify their portfolio. However, investors should be aware of the risks associated with investing in the European market. These risks include currency risk, regulatory differences, and political risks.
Currency risk is the risk that foreign exchange rates will negatively impact the value of investments denominated in foreign currencies. Regulatory differences may impact the performance of investments in the European market due to differences in regulation between the US and European markets. Political risks may arise from changes in political leadership or policies that impact the European market.