They’ll Be Wearing Cowboy Hats in Paris If This Keeps UpMichael P. Regan
Here are three things that every smart American investor should know about Europe: they call a Quarter Pounder a “Royale With Cheese;” everyone in France wears a beret with their name on it; the region’s equities have never been valued as closely to American stocks.
OK fine, that second part isn’t true. It’s just a bad interpretation of European culture from a good American movie. But given the way things are going, American and European interpretations of equity values have never looked more similar.
The Euro Stoxx 50 Index has rallied almost 6 percent this year after an 18 percent gain in 2013. The benchmark gauge is trading for about 14.8 times its companies estimated earnings over the next 12 months. That’s the highest it’s been in Bloomberg data going back to 2005, and last week the index’s valuation discount to the Standard & Poor’s 500 Index was the smallest on record based on forward profit estimates.
What in the name of Le Big Mac is going on here? Wasn’t this the region that was falling apart at its finely-tailored seams not too long ago? Is the euro area’s 1.1 percent projected economic growth this year that exciting? Or are bubbles percolating in the fondue pot?
“Positioning is not extreme,” Credit Suisse Group AG’s London-based strategist Andrew Garthwaite writes. “The potential for superior earnings growth is not yet fully discounted.”
Garthwaite acknowledges the rising valuations, which by his math show that non-financial price-to-earnings multiples are 11 percent above their 15-year average relative to global markets. However, he forecasts profit growth of at least 40 percent in the euro area over the next three years, the most of any of the world’s major regions.
The European Central Bank’s new stimulus plan, including lower interest rates and funding for bank loans, has Garthwaite bearish on the euro but bullish on European stocks in general and Italy in particular, as well as banks, auto companies and German real estate. He sees the ECB’s lending program helping boost the valuation of banks to 1.3 times tangible book value from the current 1.1.
Omar Fall and his colleagues at Jefferies LLC are among the other analysts chiming in this morning, calling the ECB lending program a “win-win” for European bank stocks. One win would come if the stimulus resuscitates a sick lending market. And even if that doesn’t happen, banks should be able to benefit from a type of “carry trade.” (That is, picking up that cheap ECB dough and carrying it over to sovereign bond markets.)
“There is a clear incentive for banks to take up their full allocation and benefit from a close to 3 percent carry yield in Italy and in Spain,” the Jefferies analysts wrote. “As we have seen in the past, as unhealthy as this may be for the ’real economy,’ it has been a boon to risk assets.”
Yup, those Europeans are sounding more and more like Americans. Maybe they’ll even put on some helmets and shoulder pads and finally start playing “football” the right way.