European Stocks Are Cheaper Than During Last Recovery

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Photographer: Ralph Orlowski/Bloomberg

A bull and a bear statue stand outside the Frankfurt Stock Exchange in Frankfurt.

European stocks have risen half as much as global benchmarks this year, leaving them cheaper than equities in the U.S. and Asia as the region’s economy starts to recover from the longest recession on record.

After a 7.2 percent gain in 2013, the Euro Stoxx 50 Index (SX5E) trades at 12.5 times projected earnings, 6.7 percent less than in 2009, the last time the euro area was in the final quarter of a contraction, data compiled by Bloomberg show. In the U.S., where the economy is in its 10th straight quarter of growth, the Standard & Poor’s 500 Index is valued at 15.3 times estimated profit and Japan’s Topix trades at 14.2 times income after Prime Minister Shinzo Abe vowed to end two decades of deflation.

Investors from JPMorgan Chase & Co. to Barclays Plc say European stocks are cheap as the first expansion for euro-area manufacturing in two years helps drive forecasts for profit growth of more than 10 percent in 2013 and 2014. Bears point to concern that next month’s German election may lead to a push for tougher austerity measures in Europe’s weakest economies.

“Compared with the last time the euro zone was improving, stocks look relatively cheaper,” Kerry Craig, a London-based market strategist at JPMorgan Asset Management, said by telephone. His firm oversees $1.5 trillion globally. “If you have a continued period of things not getting worse and data getting better, that will build confidence in markets and people will move into equities.”

2013 Performance

The Euro Stoxx 50 rose 0.5 percent last week as China’s industrial production topped economists’ forecasts. The gauge of the 50 largest companies in the euro area has trailed this year’s 14 percent rally in the MSCI World Index of developed-market shares, while also lagging behind the S&P 500’s 19 percent gain and the Topix’s 33 percent surge, according to data compiled by Bloomberg. The euro-region index added 0.1 percent to 2,827.15 at the close of trading today.

Stocks in Europe will increase another 3.5 percent by the end of 2013, according to the average forecast of 14 strategists surveyed by Bloomberg. In the same period, the S&P 500 (SPX) will fall 0.9 percent, according to a separate poll. European equities offer better value than other developed markets, according to Nader Naeimi, head of dynamic asset allocation at AMP Capital Investors Ltd. in Sydney.

“A lot of good news is already priced into the U.S. share market, whereas in Europe we’re restarting a recovery,” Naeimi, whose firm manages more than $130 billion, said by phone on Aug. 8. “Earnings recovery usually has a lag with economic data, so we expect some tangible results coming in by end of this year or early next year.”

Economic Growth

Economists project the euro-area economy will expand in the fourth quarter after seven straight contractions. The median forecast in a Bloomberg survey of 34 economists calls for 0.2 percent growth in the final three months of 2013.

The last time the region was poised to exit a recession, in 2009, the Euro Stoxx 50 traded at an average of 13.4 times projected profit, data compiled by Bloomberg show. The S&P 500 traded at 17.5 times estimated income in the final quarter of 2009, while the Topix was valued at 35.1 times forecast earnings, the data show.

A manufacturing index for the 17-nation currency bloc rose to 50.3 in July, according to a survey of purchasing managers by London-based Markit Economics, the first time since July 2011 the gauge topped the 50 level that indicates growth. Separate reports showed unemployment in Spain and Portugal fell for the first time in two years during the second quarter, while German industrial production in June jumped the most in 23 months.

Easing Austerity

Europe’s economy is showing signs of growth as governments relax efforts to trim deficits, according to Pierre Lapointe, the Montreal-based head of global strategy and research at Pavilion Global Markets Ltd. The European Commission in May gave France and Spain two more years to meet budget targets, easing austerity policies championed by Germany to combat the region’s debt crisis. Portugal won one extra year.

“European fiscal austerity is now receding,” Lapointe wrote in a report on Aug. 1. “Most European countries will see a significant reduction of fiscal tightening in 2014. This is a very big deal, as it removes a large headwind to aggregate demand.”

The euro-region debt crisis is far from resolved and campaigning in the weeks preceding Germany’s Sept. 22 parliamentary elections may focus investor attention on the issue, according to Andreas Hoefert at UBS AG. Social Democratic candidate Peer Steinbrueck is looking to unseat Chancellor Angela Merkel, whose Christian Democratic Party rules in coalition with the Free Democrats.

Berlusconi Conviction

In Italy, the conviction of former Prime Minister Silvio Berlusconi for tax fraud is creating tensions in Prime Minister Enrico Letta’s government. Berlusconi’s party has rallied around its leader, possibly seeking a presidential pardon and threatening a mass resignation of deputies in parliament.

“We are still not out of the woods,” Hoefert, the New York-based chief economist and regional chief investment officer for Europe at UBS Wealth Management, which oversees $1.7 trillion, said in a phone interview on Aug. 7. “We still have the German election. Some anti-Europe rhetoric may come back into play. At this point we feel more comfortable in the U.S. than in Europe.”

While economic reports indicate Europe will return to growth, the recovery may be too weak to boost earnings, according to Andrew Milligan, head of global strategy at Edinburgh-based Standard Life Investments Ltd.

‘Knock-Out Figures’

“There are fewer negatives for European equities than in the past, but still not that many positives,” Milligan, who helps oversee about $277 billion, said by phone on Aug. 8. “Although valuations are very certainly supportive, it’s difficult to see any knock-out figures that encourage you to go decisively overweight in European equities.”

The Euro Stoxx 50 plunged 19 percent during July and August 2011 amid concern Greece would default on its debts and leave the euro region. The speculation pushed European Central Bank President Mario Draghi to pledge in July 2012 to do everything possible to preserve the single currency and later announce an unlimited bond-purchase program.

The worst days of the fiscal crisis are over, according to Barclays’s wealth-management unit. Analysts project profits will climb 29 percent for Euro Stoxx 50 companies in 2013 and 13 percent in 2014, data compiled by Bloomberg show.

“Investors should allocate more to European equities since the risks involving the euro zone have been reduced,” Henk Potts, who helps oversee about $310 billion as an investment strategist at Barclays Wealth & Investment Management in London, said by phone on Aug. 7. “We have taken advantage in recent months of cheap valuations in Europe.”

Book Value

The Euro Stoxx 50 is trading at 1.31 times the value of its companies’ assets, data compiled by Bloomberg show. The ratio of share prices to so-called book value for the S&P 500 is 2.49.

“European stocks are more undervalued than U.S. or Japanese equities,” David Herro, the Chicago-based manager of the $21 billion Oakmark International Fund, said in an Aug. 8 phone interview. “As we’re now seeing signs of stabilization, people are going to start to want to take advantage.”

Herro’s fund has beaten 96 percent of its peers in the last five years, data compiled by Bloomberg show. He owns shares in Daimler AG (DAI), the Stuttgart, Germany-based maker of luxury cars, and Fiat Industrial SpA (FI), the maker of commercial and agriculture vehicles spun off from Fiat SpA in 2011.

Auto Market

Daimler, which has jumped 31 percent this year, forecast in July significant gains in second-half earnings as the western European auto market bottoms out and new models spur demand. Shares of Turin, Italy-based Fiat Industrial have climbed 15 percent in 2013 as second-quarter revenue rose 3.1 percent.

“We’re very pleased with the performance of our stock this year,” Heinz Gottwick, a Daimler spokesman, said by phone on Aug. 9. “We’re sticking to our statement that earnings will improve in the second half of the year, giving us a good starting point for 2014.” A spokesman for Fiat Industrial declined to comment.

Financial firms and companies most reliant on economic growth have the biggest potential for gains, according to Credit Suisse Group AG. Andrew Garthwaite, a strategist at the Swiss bank who upgraded continental European equities to overweight last week, recommends buying shares of media, airline and software companies, as well as banks.

French Banks

BNP Paribas SA (BNP), Societe Generale SA (GLE) and Credit Agricole SA (ACA), France’s largest banks by market value, reported second-quarter profit that exceeded analysts’ estimates. Paris-based Societe Generale, which said income more than doubled from a year earlier, trades at 10.8 times projected earnings, 64 percent below its 2009 high. Credit Agricole trades at 8.6 times projected profit and BNP Paribas at 10.7 times, according to data compiled by Bloomberg.

Julia Boyce, a spokeswoman for BNP, and Antoine Lheritier, a spokesman for Societe Generale, said they had no comment on the stock performance of their respective companies. Anne-Sophie Gentil, a spokeswoman at Credit Agricole, could not be reached for a comment.

While the S&P 500 has recovered all of the losses from the global financial crisis, the Euro Stoxx 50 is trading 38 percent below its July 2007 peak. Spain’s benchmark IBEX 35 (IBEX) remains 45 percent below its November 2007 high and Italy’s gauge is 61 percent lower than the level reached in May 2007.

That gives the potential for European shares to beat those in the U.S. and Asia in the near term as the recession draws to a close, according to Francois Savary, chief investment officer of Reyl & Cie.

“Europe may surprise within the global economic recovery and recent numbers have proved that this is the case,” Savary, whose firm oversees about 8 billion Swiss francs ($8.7 billion), said by phone from Geneva. “The stabilization is coming earlier than expected, which means you have good potential for equities in the next six to 12 months.”

To contact the reporters on this story: Inyoung Hwang in London at ihwang7@bloomberg.net; Namitha Jagadeesh in London at njagadeesh@bloomberg.net

To contact the editor responsible for this story: Andrew Rummer at arummer@bloomberg.net

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