So one of the things we (and others) noted going into the first round of the French elections was that investors and traders were hardly bearish on anything European.
“Overweight” European equities was on everyone’s reco list, € credit was (still) asleep at the wheel despite sovereign spreads’ best efforts to convey redenomination risk, and as for the perceptible hedging in the euro, well it was just that – hedging. Which meant a whole lot of people were long (see here for more than you ever wanted to know about that).
Well, now that the market got what it wanted (the heavily-favored Macron in the runoff), it’s worth asking if the bull thesis for eurozone stocks has become even more compelling.
That’s what SocGen’s Andrew Lapthorne set out to explore on Wednesday by way of a comparison with US equities. What he found was more interesting for what it said about the US than for what it said about Europe. Specifically: US equities are really, really expensive.
Excerpts from his latest note are below.
Enthusiasm for Eurozone equities was already on the rise before the market pleasing firstround of the French election. But even before this week’s rises Eurozone equities were outperforming the global developed market benchmark. Pro-Eurozone equity arguments are based on expectations of a long-awaited profit recovery, relatively attractive valuations and ‘a sense’ that the worst is now over for its financial sector. A good starting point is to look at each one of these questions one by one. For the sake of simplicity we will focus on a Eurozone (or Europe ex UK when we lack the necessary history) versus US comparison.
Firstly, are Eurozone valuations notably ‘cheap’ and/or ‘cheap’ versus other regions? The chart below clearly shows the Eurozone to be trading at a discount to the US, but this 20% P/E discount versus the US has been reasonably consistent over the last 15 years and both the US and the Eurozone are trading at a 20% premium to their 15 year history, or less if you include the TMT bubble.
So currently aggregate 12m forward valuations are not particularly attractive. However any comparison between markets is likely to bring up regional sector composition arguments with the US bulging with exciting mega-cap tech stocks whilst the Eurozone is inflicted with large yet still struggling Financials. Our simplest way of measuring stock picking potential in any market is to look at the median valuation measures as these help neutralise many of the market composition arguments.
But again even on these measures the Eurozone does not look particularly attractive, but the US does look extremely expensive. Indeed this is where a big difference between the two regions starts to emerge, particularly when observed on an EV/EBITDA basis with the US trading at a 30% premium to its average compared to a 13% premium for the Eurozone. Again neither is ‘cheap’, and therefore a large part of the apparent valuation attraction could be a lack of choices elsewhere.
The biggest gap however can be seen when we look at cyclically adjusted P/E ratios (CAPE) or those based on some moving average or trend-based earnings denominator. What is apparent from this analysis is that for a large part of the last 40 years, Europe ex UK equities and US equities traded on very similar trend P/E valuations and it was only during the Eurozone crisis that a significant break opened up.
There’s more, but you get the idea. While eurozone stocks may not be cheap relative to history, they’re cheap relative to the US, where equities have run far ahead of anything that even approximates rationality.
Ultimately though, the scariest chart of all is probably this one: