Many U.S.-based investors today have a “home bias,” meaning they’re generally overinvested in domestic stocks and underinvested in international equities. After an eight-year bull market, however, U.S. stocks have underperformed the global benchmark over the past 12 months, while European equities have outperformed in the same time frame. 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
As a result of a long period of underperformance, 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 $1.23 for every $1.00 of European sales, the deepest discount to the U.S. since the mid-2000s. Meanwhile, U.S. equity valuations are stretched relative to their historical average.
Sources: Bloomberg, OppenheimerFunds, 6/30/17. Note: P/S = price-to-sales ratio. Ranked from left to right—from highest P/S to lowest P/S. ACWI = All Country World Index. Europe average since 12/31/98. Shaded areas denote global all-industry contractions. SD = standard deviation.
Euro Area Monetary Policy Remains Extremely Accommodative for Now
For the first time in nearly a decade, the risks to the global economy are centred in the U.S., not in other major economies. The U.S. Treasury yield curve is flat, and the U.S. Federal Reserve intends to reduce the size of its balance sheet. Meanwhile, growth in much of the rest of the world is stable or accelerating, especially in Europe. While emergency monetary policy settings won’t be around forever, the European Central Bank (ECB) continues to support growth through the use of counter-cyclical measures. To be fair, Europe’s bond-buying programme began in 2015 versus 2008 for the United States, putting Europe’s recovery behind the U.S. As a percentage of gross domestic product (GDP), however, Euro Area central bank assets (38%)—which are high and rising—have eclipsed those of the U.S. (23%)—which are lower and falling.
Sources: Haver, OppenheimerFunds, 3/31/17. Note: GDP = gross domestic product. ECB = European Central Bank. Fed = Federal Reserve. See page 14 for index definitions. Past performance does not guarantee future results.
Accelerating European Growth Supports Equity Returns
Further, a sound economic and earnings recovery is taking place across the continent, supporting share prices. Euro Area GDP rivalled U.S. growth in the first quarter of 2017 and 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 Ireland, Spain, France, Germany and Italy. Abundant shades of green are positive, signifying EU economies in various stages of expansion.
Sources: Bloomberg, Haver, Markit, OppenheimerFunds, 6/30/17. Note: EU = European Union. Composite = manufacturing + services. PMI = Purchasing Managers’ Index. EU Composite PMI = France, Germany, Ireland, Italy, Spain, and the UK. MSCI Europe Index price returns in U.S. dollars. Shaded areas denote EU all-industry contractions. Austria, Denmark, and the Netherlands = manufacturing PMIs as services PMIs don’t exist for those economies. Past performance does not guarantee future results.
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.