Right, so earlier today we noted that just a few weeks after everything was supposed to be “fixed” in Europe (thanks to Macron vanquishing the blonde, dancing Nazi), political risk reared its ugly head again in Italy, causing BTP-bund spreads to widen materially and triggering some rather ugly action in Italian banks.
Given that, and given that the Greece “problem” is quite clearly going to keep coming back thanks to the fact that the country is forever condemned to exist as a debt serf, one might be inclined to ask whether it still makes sense to favor European equities over their absurdly expensive US counterparts.
Goldman’s answer: yes. Or, “yes” but maybe options are a better way to play things given collapsing volatility differentials.
Here’s a quick excerpt from the bank’s latest “GOAL” note:
Options on MSCI EAFE and EURO STOXX 50 appear ‘cheap’ vs. S&P 500
In the past two weeks S&P 500 has recovered some of its losses against non-US equities; YTD it is down 4% vs MSCI EAFE (-6% at the lowest). Part of the reversal has been driven by the strong performance of Tech (23% of SPX market cap and up +20% YTD). This does not necessarily mean the Non-US vs US equity trade is over: we think the 10 reasons to buy Non-US equity vs US equities are still valid and remain UW S&P 500 and OW non-US equity markets over 3m and 12m.
Inflows from US investors into Europe have scope to continue, in our view, and if anything have lagged the improvement in the data. With increasing political risk (e.g., yesterday the MIB lost 2% and BTP-Bund spread widened by 11bp on fears of earlier Italian elections) and concerns over ECB tapering, we prefer implementations through options.
The 3m volatility differential between MSCI EAFE and S&P 500 is at its 1-year lows (Exhibit 1). MSCI EAFE implied volatility looks particularly cheap given its higher beta (1.3) to the MSCI World (see Exhibit 29); the beta of the S&P 500 is closer to 0.8. We continue to like buying MSCI EAFE 3m ATM calls funded by SPX calls at close to zero cost. EURO STOXX implied vol is also closer to its lows compared with the S&P 500. The 6m implied vol differentials look particularly tight considering it may cover a potential early election in Italy at end of the year.