Market Views: Will European equities outperform the US?
As stocks in the US get increasingly expensive after a 15-month rally, investors have turned their attention to European stocks for their attractive valuations and earnings growth potential.
Vaccine optimism and fiscal stimulus have given the US economy an earlier boost than Europe. The MSCI USA Index is now 30% more expensive than the MSCI Europe Index based on forward earnings, the biggest premium in more than 20 years.
In addition, 2022 earnings per share growth for companies in the Euro Stoxx index is forecasted at 17%, compared with S&P 500 firms at 12%.
Anticipating a recovery in earnings, the MSCI Europe has jumped 40% since the end of October, outperforming the S&P both in local and US dollar terms.
Investors’ opinions vary on whether European stocks are more attractive than the US. Those in favour eye reasonable valuations and earnings potential, while others note that consumer spending and long-term earnings growth are stronger in the US.
But they all agree that with favourable monetary and fiscal policies, as well as growing vaccination rates, opportunities exist in Europe’s cyclical and ESG stocks.
AsianInvestor asked fund managers whether the European stocks are more attractive than the US in the next six to 12 months, and which sectors they find the most appealing.
The following contributions have been edited for clarity and brevity.
Peter Sartori, executive vice president and portfolio manager
Templeton Global Equity Group, Franklin Templeton
Relative to the global benchmark, our portfolios are slightly overweight Europe and underweight the US. For simplicity’s sake, if the benchmark is running 60/20/20 US/Europe/Asia, we’re more like 50/20/25/5, with the final 5% being cash and other assets.
We like the US because it’s a stable, dynamic market with a deep pool of high-quality companies with good growth prospects. But we also still believe that the price you pay for an asset matters, and on a relative valuation basis the US looks broadly expensive.
If the reopening trade resumes, Europe is probably better positioned given its cyclical profile; though if growth stalls or risk appetite fades, the US’s growth and quality bias should serve it in good stead.
On a longer-term basis, Europe’s more reasonable valuations position the market relatively well. We are also constructive on the economic and political progress being made on the continent as greater stability and cohesion should make Europe more investable over the long term. Environmental, social and corporate governance (ESG) investing is also a major trend in Europe and many of the opportunities we are finding in Europe, regardless of sector, are plays on ESG leadership or improvement.
Patrik Schowitz, global multi-asset strategist
J.P. Morgan Asset Management
Continental Europe is the most preferred equity region across our multi-asset portfolios. As a cyclical and export-oriented equity market, Europe offers a very attractive combination of exposure to both a recovering global economy, as well as regional economic re-opening post-Covid.
After a relatively slow start, the European Covid vaccination campaign has now taken the global lead, even eclipsing the US. This is supporting further economic recovery. In addition, monetary and fiscal policies in Europe are set to remain among the most supportive across developed markets, with the ECB unlikely to hike rates for years.
The make-up of the European equity markets should be favourable in an environment of strongly recovering global economic growth and trade: half the market’s revenue comes from outside the region – well in excess of other major developed equity markets.
Furthermore, the region’s sector mix is skewed towards cyclically-geared areas such as consumer discretionary, industrials and tech hardware – all areas that should see profits rebound strongly as the economy turns around. Even the long-challenged financial sector in Europe may begin to perform better against such a backdrop.
Finally, while not the cheapest market, valuations for the European equities remain attractive relative to other regions, with a forward price-earnings (PE) of around 16x comparing favourably to the global MSCI ACWI index on 18.5x, or the US market on 21x.
Chris Iggo, chief investment officer for core investments
AXA Investment Managers
While the US is ahead in terms of achieving a pre-Covid trend level of GDP relative to Europe, 2021 has seen European equity market performance match that of the US indices.
The large cap-stock indices in Europe have matched the performance of their US peers in local currency terms. In the small-cap space, Europe has actually outperformed. There should be no reason why Europe lags the US in terms of equity market performance as the global recovery continues into 2022. Rates are not going up and central banks remain committed to their quantitative easing programmes, at least for now. Indeed, it may be the US that starts to normalise monetary policy first. Earnings growth is strong in both markets too.
From a sector point of view, European industrial should benefit from the growth recovery and the focus on green infrastructure spending. Meanwhile, booming demand for credit should be positive for European financials.
Daniel Gerard, senior multi asset strategist
State Street Global Markets
Equities performance over the next 12 months will depend more on earnings growth and expectations, and less on valuations. Although it can hardly be argued that stocks are cheap, investors that view multiples as prohibitively high are taking too short a view of earnings. In this environment, where fiscal and monetary policy will remain supportive, we favour the US over Europe.
There are certainly opportunities within Europe, especially within cyclical stocks, but we continue to be impressed by the earnings backdrop in the US.
We expect the low-rate environment to last for years which should benefit the sector mix of the US. Earnings in the US held up the best during the pandemic and show little sign of letting up going forward. The US has seen the highest proportion of earnings upgrades within all MSCI regions. US corporates are spending more on capital expenditure this year yet they are also raising shareholder yield. Dividends and buybacks in the US are providing stable income.
Europe does benefit as a catch-up play on the reopening, and we favour some cyclicals within the region. The European industrials complex is the most attractive and we favour Germany, France and Sweden given that view. We are more cautious on Financials which will suffer from less investment banking revenue in Europe vs their US counterparts.
Mark Schumann, portfolio manager of European equities
The valuation gap to the US market is to a certain extent also a function of a lower proportion of highly valued growth sectors such as technology. This valuation gap still persists and has not really narrowed yet.
The most likely scenario in which European stocks would continue to outperform US stocks probably requires a more sustained earnings growth trajectory in value and cyclical sectors such as financials, commodities and cyclical industrials and would likely coincide with higher yields and a steeper yield curve.
At this point, we do not have a strong view on the expected relative performance of Europe relative to the US. The next phase of economic recovery is likely to be considerably driven by consumer spending.
However, the valuation discount along with a likely continued global economic recovery will be supportive for Europe. Adding up the gives and takes leaves risk and reward neutral.
Finally, EU legislation is providing a very benign backdrop for companies exposed to the strong trend towards carbon emission reduction. Companies benefiting from this can be found in Building Materials (Insulation), Automotive (Electrification) and Renewable Energy sectors.
David Chao, global market strategist, APAC ex Japan
I believe that European equities will outperform US equities over the near term underpinned by strong corporate earnings as the EU economy continues to reopen and the valuation gap narrows.
Meanwhile, fundamentally, the potential for economic growth is still very material since the region has lagged behind China and the US in economic recovery. Lagged recovery means corporate earnings growth could be underestimated. Despite growth peaking in a number of US and Chinese activity indicators, growth is likely to stay above trend in the final four months of the year for Europe, supported by both strong consumption and capital expenditures. Strong Purchasing Managers' Index (PMI) numbers suggest the Eurozone growth is expected to outpace that of the US in the coming quarters.
Besides, EU monetary policy should remain supportive of European risk assets for a longer period of time compared to the US. Symmetric target of 2% inflation is clearer and means there is still ground to cover before inflation can be at 2% in a stable manner.