Europe Has Never Been This Cheap Versus The US

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by Tyler Durden
Tuesday, Nov 16, 2021 - 02:00 PM

By Michael Msika, Bloomberg Markets live commentator and analyst

If you liked European stocks at a 25% discount to U.S. peers, you should like them even more being a third cheaper. So say a growing number of market strategists, with bullish calls showing no sign of abating.

Europe has never been this cheap versus the U.S. The MSCI Europe Index this month hit a record of about 30% discount to its U.S. counterpart, based on forward P/E ratios, after the latest earnings season fueled further upgrades to estimates for the region’s companies.

“European valuations look reasonable in absolute terms, very attractive in relative terms,” says Morgan Stanley’s Graham Secker. He expects some volatility in 2022, but sees 8% upside for the region’s stocks, supported by 10% earnings-per-share growth.

European equities have risen for six straight weeks, and hit record highs, on optimism that economic growth can overcome inflation, central bank tapering and supply chain risks. Yet while the MSCI USA forward P/E is hovering near a record of around 22 times, Europe’s P/E has receded to 15, well below its 2020 record, which was just shy of 19 times.

The region’s stocks don’t just look cheap relative to the U.S. Their discount to real bond yields has widened too, with a 500 basis-point gap opening up between 10-year real bund yields and Europe’s forward dividend yield.

European bulls are standing firm. JPMorgan strategists recommend being overweight against the U.S., Pictet Wealth Management cites valuations in favor of the region’s stocks, while Goldman Sachs strategists said last week that the rally in Europe had further to run.

Optimism is also growing on U.K. stocks, particularly large caps. After a year of underperformance, the FTSE 100 is one of Morgan Stanley’s key calls for 2022, while JPMorgan raised the U.K. to overweight last week for the first time since the Brexit referendum.

U.K. equities trade at a record discount to global peers, while offering the highest dividend yields of all regions.

“The de-rating in the FTSE 100 has been especially sharp and is a function of strong positive earnings revisions through the year and the fact market prices haven’t kept pace with this,” say Goldman Sachs strategists led by Sharon Bell. They expect a combination of inflows, buybacks, M&A and good earnings to drive returns in 2022.

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Meanwhile, as Bloomberg's Heather Burke notes, European consumer companies, especially on the luxury end, were the big winners in the 3Q earnings season emerging from the pandemic downturn. Distiller Diageo saw faster earnings growth than before the pandemic; the maker of Johnnie Walker is benefiting as bars and restaurants re-open. Last month, rival Pernod’s sales beat estimates.

Some luxury stocks have held up despite peers’ disappointing earnings and concerns about China growth. Richemont posted “stellar” earnings. Consumer products and services is by far the best-performing Stoxx 600 sector so far this month. Richemont, LVMH, Diageo and Hermes are all among the best-performing European stocks in terms of index points in the past week.

U.K. retail has also seen some recovery: Marks & Spencer is November’s best performer in the Stoxx 600 after raising its profit forecast. Retail and food & beverage have outperformed in the past week.

Of course, some gains are idiosyncratic: Richemont has also advanced because it’s in talks to sell its YNAP stake to Farfetch. And concerns about rising inflation and China remain. But, according to Burke, "the consumer can help power a cyclical recovery in European stocks" and also buttresses the CAC 40’s outperformance on a regional level.