European stocks are a bit of a puzzle. Why do they perform so much worse than American ones?

Last year was the best year for European stocks since the height of the Dotcom bubble in 1999. The STOXX Europe 600 index returned 19 per cent. 

Obviously, 19 per cent in a year is good going. But it says a lot about European stocks that, in their best year since 1999, they only made 19 per cent. The S&P500 beat that in 2021, 2019, 2017, 2013, 2009 and 2003. Since 2000, the STOXX has returned an average of 4.5 per cent. The S&P, meanwhile, has returned 7.5 per cent.

In the long run, the picture is even worse. $1 invested in the US stock market in 1900 compounded to $1,136 by 2014. The same investment in Germany grew to $36, France to $38, Italy $9 and Austria $1.9. 

What’s wrong with Europe? Well, for the 1900-2014 period, you’re looking at a couple of world wars and the collapse of empires. Losing a world war is not good for a buy and hold strategy. 

Then there are issues with Europe’s literal stock exchanges. They’re too small and fragmented. That drags down valuations. 

Where the US has five exchanges, Europe has 22, along with 41 different exchanges for trading. The purpose of the stock market is to be a broad, deep pool of capital; Europe has 22 ponds. That’s why you see the likes of GAN and Total Produce move their listing to the US. 

Whatever about the long run — why has Europe underperformed since 2000? I would be looking at two factors. One is that the euro has been in place since 2002. The move to a collective monetary policy has not gone well.  We didn’t get the thing the Germans worried most about — inflation — but what we got instead was grinding unemployment, low growth and low investment. Not good for stocks.

The other factor that has mattered a lot in the last 22 years has been the rise of the technology industry. Technology companies have eaten the stock market, to borrow Marc Andreessen’s phrase. The top five biggest companies in the S&P 500 are all technology companies. They make up a quarter of the value of the index. 

Never before has one industry taken over the market in this way. Since 1969, the most any one industry contributed to the value of the market was the computer industry in 1969, at nine per cent. Today, the big five technology stocks are nearly three times bigger. And there are dozens of other valuable technology stocks outside the top five.

Market structure and tight monetary policy have no doubt played their part. But when you look at the numbers, its clear that America’s technology industry is the big reason for the difference.

Which is why it’s great to see signs European tech is starting to power up. 

Progress

It took twenty years of trying for Ireland to get its first unicorn. In the four years since Intercom got the nod in 2018, three others joined the list: Fenergo, Letsgetchecked and Workhuman. And in the last two weeks, we got two more: Flipdish, and now Wayflyer. 

Unicorns are the apex predator of the startup world: a sign of the health of the overall ecosystem. If you’re seeing a lot of startups valued at $1 billion or more, it means there are lots of great smaller companies ideas and talent knocking about. 

The following charts show various metrics showing the health of a country’s startup scene. I have divided each metric by the country’s population, and then ranked the resulting number. Ireland is so small that it’s impossible to make any kind of comparison with other countries without first correcting for population. 

As you can see, Ireland looks pretty good. It’s not quite as good as Israel, which is the undisputed small-country technology industry champ. And it’s not quite as good as the US, even adjusted for population — which goes to show how outrageously strong the industry is over there. But it’s better than almost every European country, on average. The average of its rankings is 4th.

The story of Ireland is that it imported a tech industry from the US. Which is of course true. But there are signs that we’re seeing some of the much-anticipated spillover effects too. 

Pound for pound, Ireland has one of the best domestic technology industries in Europe. And Europe as a whole is getting much stronger. The following chart shows the aggregate valuation of European versus US unicorn companies. Europe is still way behind the US, but something is clearly happening. European unicorns are valued at almost the same level as US ones in 2015. 

Conor Smyth founded TritonLake, a business that matches high-net worth investors with deals. He said: “Historically, venture [capital] in Europe has been viewed as being years and years and years behind venture in the US in terms of sophistication, in terms of reach, in terms of everything else… But in the last five years, that has changed dramatically. There are some very successful venture firms in Europe… There’s absolutely an appetite now from the US in the last year or two for European venture that didn't exist three, four or five years ago.”

Digging around in the 2021 venture capital data, one strange thing I noticed was a leveling out in the total number of startups in the last four years or so, after a decade of exponential growth. The following chart shows the number of startups per country, divided by 2020 population. 

As you can see, it’s happening everywhere — Ireland, the US, Israel. And it’s interesting to see it happening while, simultaneously, startup valuations are taking off. 

The valuation bit might be coming from the financial markets — low interest rates, big risk appetite or whatever. But it’s hard to square the leveling out in the total number of tech startups. Have we reached the limit of the number of industries our current technology can gobble?

Let me know what you think. My email is [email protected].