Many U.S.-based investors today have a “home bias,” meaning they’re generally overinvested in domestic stocks and underinvested in international equities. After a nine-year bull market, however, U.S. stocks have underperformed European equities and the global benchmark over the past 12 months. For several reasons, we believe Europe should continue to outperform, and that U.S.-based investors may benefit from increased allocations to European stocks.
Attractive Valuation Relative to Global and U.S. Stocks
European stocks underperformed U.S. stocks from 2007 to 2016, owing to a failed economic recovery, fiscal austerity, and a euro currency crisis. As a result, the MSCI Europe Index’s price-to-sales (P/S) ratio has become cheap relative to that of the MSCI ACWI and USA Index. The good news is that investors have to pay only $1.19 for every $1.00 of European sales, the deepest discount to the U.S. since the early 2000s. Meanwhile, U.S. equity valuations are stretched relative to their historical average.
Euro Area Monetary Policy Remains Accommodative
For the first time in nearly a decade, the risks to the global economy are centered in the U.S., not in other major economies. The U.S. Treasury yield curve is uncomfortably flat, signaling a softer macroeconomic outlook. Compounding the problem, the Fed is reducing the size of its balance sheet and must proceed with caution. Business cycles ultimately end with tighter monetary policy and an inverted yield curve. For investors, the bottom line is that tighter monetary policy, a flatter yield curve, modest growth and elevated equity valuations are consistent with diminishing U.S. stock market returns.
Meanwhile, growth in much of the rest of the world is stable or strong, especially in Europe. While the European Central Bank (ECB) has begun tapering its asset purchases, they continue to support growth in counter-cyclical fashion. To be fair, the ECB didn’t begin its bond-buying program until 2015, whereas the Federal Reserve (Fed) began in 2008, putting Europe’s recovery several years behind the U.S. As a percentage of gross domestic product (GDP), however, Euro area central bank assets (39%)—which are high and rising—have eclipsed those of the U.S. (23%)—which are lower and falling.
Solid European Growth Supports Equity Returns
Value means little without a catalyst. The good news is that a sound economic and earnings recovery is taking place across the continent. Euro area GDP rose 2.7% year-over-year in the fourth quarter of 2017, a touch more than U.S. GDP, which grew 2.6% year-over-year in the same period.
Despite a recent slowdown, leading indicators of business activity in the European Union (EU), as expressed by the Composite Purchasing Managers Index (PMI) for the region, are in expansion territory and continue to trend upward, providing ongoing support for European equity returns.
Our Composite PMI heat map shows the broadening economic recovery in the EU, led by France, Spain, Germany, Ireland and Italy. A uniform shade of brilliant green is positive, signifying EU economies in synchronous expansion. In short, green stands for “go” in Europe.
Overall, we believe that compelling valuation opportunities exist for investors in European stocks at a time when the economy is expanding, earnings are recovering, and the ECB is lending a very large, visible hand. That’s a powerful combination for unlocking the potential reward embedded in European share prices.
For the full list of factors, please see our white paper, “9 Reasons to Consider European Stocks.”
Additionally, watch Talley Léger’s interview with CNBC on the current environment in the United States and Europe.
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These views represent the opinions of OppenheimerFunds, Inc. and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the publication date, and are subject to change based on subsequent developments.