Europe’s stock markets are sick, and there isn’t a Facebook or Microsoft in sight
Joe Chidley explores whether they can offer a smart play for North American investors
European equities are hardly the things to set the animal spirits of an investor surging. Perhaps it’s just New World bias showing, but I can’t think of one European CEO or company that can be called transformational in the way of Zuckerberg or Tesla. (Can you?) Europe’s exchanges don’t boast among their listings any fantastic FAANGs or well-known entrepreneurial wunderkinds.
For comparison purposes, consider that the largest three companies in the United States by market cap are Microsoft, Amazon and Apple. The Big Three on the MSCI Europe index, out of 439 constituents? Nestle, Novartis and Roche — all fine international conglomerates, granted, but, well, not exactly revolutionary. By the way, the market cap of Microsoft, at about US$822 billion, is bigger than those top three Euro stocks combined — and you can throw in the fourth, HSBC, and still not get there.
Well, so what? From an investor’s perspective, boring can be good — even if the growth stocks have been capturing the headlines and the lion’s share of gains over the past few years. But now, with the FAANGs under assault from regulators seemingly everywhere and the bloom coming off the growth rose as the end of the business cycle (maybe) looms, could dull old Europe offer up a smart diversification play for North American investors?
From a sheer valuation perspective, European stocks look like a big value over their U.S. counterparts. Late last year, the price-to-earnings ratio of the MSCI Europe index hit a five-year low, and today stands at 14.88 on a trailing 12-month basis, compared with the S&P 500’s 20. Even on a forward basis, the difference is still there, with European stocks valued at 12.6 times forward earnings and the S&P 500 valued at 16 times. The other thing about Euro equity is that they pay dividends. The dividend yield of the MSCI Europe index is 3.8 per cent, compared with just two per cent from the S&P 500.
Price-to-earnings is a pretty blunt instrument by which to measure value, particularly when applied to a market as complex as Europe’s.
The risks — many but not all of them political — certainly seem big enough to turn what might look like a value play into a value trap pretty quickly.
We’ve seen that movie before, and not that long ago. European markets started 2018 in a pretty bullish mood, in part because, then as now, they looked cheap. The Euro STOXX 600, a total market index of large-, midand small-cap companies, was approaching its all-time high in January. But by around June, the wheels started to come off, and by mid-December the index had fallen by about 18 per cent.
At least some of the fall-off came as the result of concerns over the global economic outlook, sparked by the tariffs on Chinese goods imposed by the U.S. The European economy is heavily reliant on trade — it comprises almost 90 per cent of GDP in the euro area, compared with about 30 per cent of GDP in the U.S. Like stocks closer to home, Europe has recovered from those lows even as hopes have risen for productive trade talks between the U.S. and China.
But not everything dogging European stocks can be laid at the door of the Trump tariffs. The fallout from a hard Brexit would be felt throughout the continent. Italy, whose economy could shrink this year, is borrowing heavily under its populist government, threatening to undermine the European Union even further. France has been grappling with the yellow jackets, and Germany — the economic powerhouse of Europe — saw industrial output fall for the fourth straight month in December. Beyond the Brexit deadline of March end, there are European Parliament elections in May, as well as potentially divisive votes in Spain and Sweden.
Meanwhile, the European Central Bank has halted its quantitative easing program in January — for the first time in four years. But the ECB has also cut its growth outlook for 2019 (to 1.7 per cent) last December, and some of the governing council’s more hawkish members, like Klaas Knot of the Netherlands, have recently started sending out some dovish signals. That suggests that the path toward normalization is still unclear in Europe — and last month’s QE halt might end up just a pause.
That would likely be welcomed by equity markets.
The bigger question is whether investors can start looking beyond the multitudinous downside risks. If they are going to materialize, it should be sooner rather than later. The first half of this year could determine the outlook for global trade, depending on the outcome of the U.S.-China negotiations. The Brexit deadline is fast approaching, and even an extension will likely be seen as good news for stocks. As for elections — well, populists can lose, too.
In short, we don’t know whether the risks in Europe have got as bad as they are going to. But if they don’t get any worse — and we might know that in the next few months — then maybe European equities really will turn out to be the value they seem to be. Financial Post