Europe Looking Cheap?

In the past month, U.S. investors have been pulling money out of European equity funds. Through June 5, about $20 million has flowed out of the seven European stock funds tracked by TrimTabs Investment Research. That’s a 0.82% drop for the $2.5 billion in those funds — not an eye-popping decrease certainly, but interesting to watch.

Alec Young, international equity strategist at Standard & Poor’s, wrote about the environment for European equities today. His observations are worth summarizing:

1. European economies are slowing, but they’re not stopping. Germany, France, Spain, the United Kingdom and the Eurozone as a whole are all expected to grow between 1% to 2% this year. That’s a slowdown from 2007, when most grew 2% or more, with the UK and Spain up more than 3%.

2. In January, analysts expected European stocks’ earnings-per-share to grow 10% in 2008. Now, EPS is expected to increase 5% this year.

3. European stocks trade at 11.2 times their estimated 2008 earnings, which, Young says, makes “Europe the cheapest developed equity market in the world.”

4. However, investors are unlikely to take advantage of those cheap valuations “until the profit outlook stabilizes,” Young writes. “As such we think European equities will remain range bound over [the] next few months.”

5. The weakening dollar improved European stock returns for U.S. investors. But the Federal Reserve may be done cutting interest rates, and that has helped stabilize the dollar, “making a continued strong currency tailwind less likely.”

All in all, it sounds to me like European stocks face a tough outlook in the short term, but might be a good long-term investment with valuations so cheap. The problem for U.S. investors: A strong recovery for the U.S. dollar – if it ever comes – could take a bite out of European returns.

(S&P, like BusinessWeek, is a unit of the McGraw-Hill Companies.)