With the S&P 500 already up 26% since its late October low, money is starting to flow into European stocks. Investors should expect this to continue.
THE
S&P500
has become expensive, while
Stoxx Europe 600
No. The S&P 500 now trades at 20.7 times the earnings per share its component companies are expected to generate over the next 12 months, up from just over 17 times at the start of the rally that began in October.
Expectations for earnings estimates haven’t changed much. Rather, the gains were driven by expectations that the economy would continue to grow, which would also lead to higher corporate profits. Investors are betting that the Federal Reserve will succeed in beating inflation without pushing the economy into a recession and that it will soon be able to begin lowering interest rates.
The problem is that current stock valuations are probably just too high, given that the 11 rate increases implemented by the Fed since March 2022 make bonds a much more attractive investment than they were ago. a few years ago. The yield on 10-year Treasury debt is now about 4.29%, while the profits S&P 500 companies are expected to generate in the coming year are about 4.8% of the index price.
That’s not even a percentage point higher than the yield on ultra-secure Treasuries, so taking the risk of owning U.S. stocks has become less attractive. Fund managers are responding by turning to international markets.
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On average, fund managers increased the share of their portfolios devoted to euro zone stocks more in March, compared with February, than for any other asset class in the world, according to a Bank of America survey. The biggest reduction in allocations was to US stocks.
And this change is probably not over. The share of fund managers who say their funds are overweight euro zone stocks remains near historic lows.
Placing a larger share of assets in European stocks makes sense because they trade at one of the deepest discounts to the U.S. in a long time. The Stoxx Europe 600 trades at 13.8 times forward earnings, an unusually large discount of 33% to the S&P 500, according to FactSet.
Even in August 2020, as tech stocks pushed the S&P 500 ever higher and investors avoided more economically sensitive names, like those that make up most of the European index, the Stoxx Europe 600 downgraded compared to the S&P 500 was only 20%.
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And the earnings yield of the Stoxx Europe 600 is much better than that of the S&P 500. The expected earnings for the coming year amount to 7.2% of the price of the European index, which is much better than the yield on US bonds, better than the 4.1% on UK 10-year debt, and well above the just over 2% on German 10-year debt.
Money should flow into the European market as long as economic developments in Europe proceed as planned. Economists forecast real growth of less than 10% for Germany, the United Kingdom, Italy and France for the next two years, according to FactSet. If inflation continues to moderate, as expected, the European Central Bank would be able to cut interest rates, which would keep money flowing through the economy and allow sales and profits to rise. businesses to grow.
The picture is positive for European stocks compared to the United States
Write to Jacob Sonenshine at [email protected]