US is at a 40-year high relative to Europe(outperforming by 105% since 2008). With big secular shifts in the wind (economic recovery, reflation, fiscal stimulus, etc.) investors are naturally curious to evaluate the case for Europe. Analysts at BoAML does it and conclude the region is cheap vs the US, especially on PBV(near 40-year relative lows). On the other hand, the UStrades at a relative premium to its history on 12 of 14 metrics, and only looks cheap vs bonds.
Strong case for Europe – dependent on earnings & politics
The value case for Europe vs the US is subject to two important conditions. First,a turn in the EPS cycle in Europe is paramount. Second, that political / sovereign tail risks in Europe are avoided. According to BoAML:
Some clarity is likely later in 2017 and in fact perceived political risk could turn positive if more reform-minded leadership comes to power. For now Europe vs US is likely to be somewhat choppy until the political uncertainties clear.
Earnings explains why Europe lagged but tide is turning
The key reason that the US has outperformed Europe is growth (US EPS has outgrown Europe by 76ppt since 2009). US margins are near highs while, EPSand margins are subtrend in Europe. The house’s economists forecast for a synchronized upturn in the global cycle points to a rebound in European profits -EPS in relative terms is already rising.
We forecast higher EPS growth in Europe in 2017/18 (20% vs 16% cumulative in the US). A strong earnings recovery could be the catalyst to unlock the value potential in Europe.
Sector composition doesn’t alter conclusions
Thee also found that sector composition has been a big factor in earnings contribution for the two indices (a larger US Tech sector and more Financials in Europe), but it does not change the valuation call. In fact, on a sector neutral basis,Europe’s relative PE is similarly inexpensive, and its PBV-relative is 15% below the 20-year historical median.
The Europe vs. US sector guide – relative trades
Valuation supports many of the experts’s sector overand underweights.
We prefer European Energy, Utilities and Materials over the USpeers. We are overweight Financials in both regions as reflation beneficiaries:valuation, positioning favours Europe,whereas rising CB rates andpotential de-regulation favour the US. We prefer US Telecoms and Consumer Discretionary.
