In the view of many investors, Europe has been lurching from crisis to crisis for a decade. Following the global financial crisis, Europe has faced challenges including a near default in Greece, threats of a possible break-up of the euro, and most recently Brexit, all of which have dragged on the region’s economic growth and equity prices. Lately, however, indicators point to the potential for European equities to outperform those in the U.S.
Since 1973, returns from European and U.S. equity markets have generally kept pace with each other. Over these 44 years, Europe has outperformed in 23, or just over half the time. However, in recent years, U.S. stocks have maintained a positive trajectory while European equities have been more volatile. For example, during the last seven calendar years the U.S. has outperformed in six. The last time we saw a similar pattern of near-consecutive outperformance of U.S. stocks was 1995-2001. Subsequently, European stocks outperformed for the next six years. Given this history, we expect closure of this more recent performance gap— and we may indeed be seeing the beginnings of this reversion with European equities outperforming the U.S. year-to-date.
Despite the similar longer-term performance of European and U.S. stocks through the years, European companies have typically traded at discounts to U.S. stocks on many valuation measures. As of their last reported price/earnings, European stocks traded at an 11% discount which is in line with most of history. However, on price/book Europe was trading at a 39% discount, which is far deeper than normal. Beyond these discounts, two points are worth noting. First, European stocks currently provide far more generous dividends than U.S. companies, with 3.3% and 2.0% yields respectively. This has advantages to investors who may not be able to easily liquidate principal. Second, expected earnings growth for the current fiscal year versus last year is considerably higher for European companies, at +19%, than for those in the U.S., which have a +11% growth forecast. Given their lower valuations, this expected additional earnings growth makes European equities all the more attractive.
Catalysts for recovery
In addition to technical and valuation drivers, there are reasons to expect strong economic and market performance in Europe. Although the Bank of England has recently reduced its growth forecasts citing lower investment and spending in the face of uncertainty surrounding Brexit negotiations, there are positive signs elsewhere in Europe. Offsetting weakness in Britain are investments by financial institutions in Frankfurt, Dublin, and other cities staying within the European Union. Perhaps more important are labour reforms focusing on reducing unemployment and increasing output. Since the 1990s and early 2000s, a number of European countries have implemented policies that allow temporary employment contracts, reduce long-term unemployment benefits, and support training and placement programs. More recently, President Macron of France has made further liberalization of labour markets central to his new economic plan. The degree of labour reform still varies across Europe and can take considerable time to show material results, but the trend is clear and equity markets often respond in advance of measured economic gains. Adding to these developments is the trade surplus enjoyed by Europe. Exporters in particular should benefit from the recovery we are seeing in global economic activity.
Brian K. Wolahan, senior vice president, senior portfolio manager, Acadian Asset Management