Why wouldn't you invest in European stocks?

Serious Money: Why would anybody invest in Europe's stock markets? The list of problems facing European companies is as long as it is depressing, writes Chris Johns.

Slow or non-existent economic growth is corporate enemy number one.

High unemployment, a heavy regulatory burden, lousy demographics, restrictive labour laws and high taxation all figure prominently whenever we think of the European business environment.

Economic policy is in total disarray, with a central bank uninterested in stimulating growth and determined to do battle with the ghosts of past inflation; fiscal policy is now in limbo following the collapse of the infamous and badly named "growth and stability pact".

The less visible signs of capitalist life like the venture capital environment or the health of the private equity sector suggest that the patient is comatose, if not actually deceased. And there are plenty of other ways in which we can give Europe a kicking.

Despite paying lip service to something called the "social market economy" (now formally enshrined in the draft constitution by the way), few politicians are comfortable with the market bit of that statement.

Policies aimed at doing something about Europe's problems, like the EU-wide Lisbon Agenda or Germany's own Agenda 2010, have failed to deliver; indeed, all of Europe's efforts to reform itself structurally have been accompanied by the rest of the world further accelerating its own reform programmes.

Every time Europe takes a small step down the reform path it exhausts itself and takes a few years off to recover.

Meanwhile, Asia and America continue to power ahead.

Most governments are intrinsically hostile towards business and have an atavistic dislike of anything to do with the private sector.

The lack of properly funded pensions - and other inadequacies in the personal savings market - represents a structural impediment for the development of equity markets, contributing to stock markets that are relatively small and immature when compared to their global counterparts.

Politically, Europe has lost its way, with the latest furore over a constitution that is unreadable - let alone understandable - being accompanied by an electorate clearly determined to signal that the democratic deficit has grown too large for comfort.

Markets prefer stable and predictable politics: does Europe offer such an environment?

Put this way, the case for investors avoiding European equities would seem to be cast iron. The prosecution witnesses are credible and the evidence is hard, not circumstantial. Does the defence have any chance at all?

Surprisingly perhaps, there is a perfectly reasonable riposte to all of this, and it contains several strands.

All of the earlier arguments do contain much - but by no means all - that is true but they vary widely in their applicability. For example, they apply much more to Germany than they do to France; a close examination of French data reveals a corporate sector that has been doing much better than many people seem to expect. Everyone knows that the US has had a productivity miracle over much of the last decade, few people realise that French productivity in many areas is better than that of America.

Indeed, many of the economic gaps between Europe and the US are much narrower than is generally supposed - when things are measured properly the gaps are still there but smaller.

The acid test: where is the best place to invest our money, the US or Europe?

Given all of Europe's woes, most of us instinctively believe that it would have been far better to have been invested in Wall Street than European equity markets. Not true.

For example, the real total return on equities since 1950 has been 7.7 per cent a year in the US. The real return from German equities has also been 7.7 per cent. Admittedly, much of that German performance came in the earlier part of that period but if we look to some other European markets we find that, over the last decade, they have either matched or even beaten returns obtained in the US.

Sweden, Ireland, the Netherlands and Switzerland are some of the markets that historically can match the US.

Some would argue that many of these countries allow companies to operate in an environment more like the US than core Europe. Again, this argument contains a kernel of truth but the real explanation is far more complex.

The truth is that, despite everything, the European economy is becoming ever more integrated with the global economy and that means becoming more and more tightly linked to the world's largest economy, the US. That's the simple consequence of globalisation.

One way in which this is clearly visible is the degree of correlation between European equity markets and Wall Street. That correlation has never been higher.

The European stock market is simply becoming an extension of the US market.

Globalisation means that companies must compete globally and overcome local difficulties. European companies must discover ways around domestic obstacles or die.

If European companies cannot offer acceptable returns to global investors they will die.

If globalisation is the competitive pressure, increasingly easy technology transfer along with similar management practices (all MBAs are the same) produce companies that are truly global, rather than particularly European.

When performance gaps open up between European and US companies, investors should see this as much as an opportunity as it is a threat.

Where the US leads, successful European companies will follow; periods of European stock market under-performance will be followed by out-performance.

Europe's problems mean that we have relatively few investment opportunities, our stock markets are smaller than they should be and we have relatively fewer successful companies to invest in. But those companies that do exist can often be world class.

Europe, properly understood, belongs in every investor's portfolio.