Decade-Wide Value Gap in Europe Stocks Underscores Mistrustby
Investors turn to defensives; favor consumer, health shares
Lenders trade at record lows relative to the broader market
This year’s rout in European stocks has led to the biggest gap in a decade between the most expensive and cheapest shares, showing the lack of faith investors have in the region’s economic outlook.
The 10 members of the Euro Stoxx 50 Index with the highest valuations, such as makeup maker L’Oreal SA and retailer Inditex SA, trade at 25.6 times estimated earnings on average, compared with 7.4 times for the cheapest companies, which are almost all financial firms and include France’s BNP Paribas SA and Spain’s Banco Santander SA. Last March, when the European Central Bank began its bond-buying program and shares were about to hit a peak, the costliest stocks were about twice as expensive as the cheapest.
Rather than getting better, evidence is mounting that the region’s recovery is faltering, with data last week showing inflation rates fell from Germany to France and Spain. The time couldn’t be worse, with companies having their biggest earnings letdown since before the financial crisis. Even speculation for more ECB support has failed to boost sentiment amid concern that ever lower interest rates will end up hurting bank profits.
“The valuation gap, especially between financials and the rest of the market, is really a problem of trust,” said Christian Zogg, who helps manage about $10 billion as head of equity and fixed income at LLB Asset Management in Vaduz, Switzerland. He favors health-care companies and sees consumer shares as too expensive now. “A lot of people in the market seem to believe that we are not in this recovery phase anymore. Investors hang on to relatively stable business models.”
This year’s plunge in lenders sent the Euro Stoxx 50 down as much as 30 percent from its April high, taking its valuation to 12.7 times projected profits from 16 then. While both the most expensive and cheapest companies have taken a hit, the multiples in the period have tumbled almost four times more for the low-cost group. The dispersion was the narrowest between 2010 and 2011, when the valuation gap was about half what it is now.
The Euro Stoxx 50 rose 0.6 percent on Monday.
Back at the end of March 2006, when the difference between cheap and highly priced equities reached similar levels, the benchmark index was heading for a fourth annual advance that it extended into a fifth year before slumping in 2008. In 2015, it completed a fourth year of gains, while stocks worldwide fell.
Adding to global-growth worries, economic data in the euro area, which beat forecasts during most of 2015, began missing projections in January. Last week, a report showed confidence dropped for a second month, increasing pressure on the ECB to act. President Mario Draghi said in January the central bank may reconsider its monetary policy stance at its March meeting, which takes place next week.
“The below zero rates in Europe and the short-term memory of the financial crisis in 2008 do really harm investors’ trust in financial stocks,” LLB’s Zogg said.
Economists have remained bullish on the recovery, projecting growth of 1.6 percent for the euro area -- the most since 2011. And strategists are betting that the Euro Stoxx 50 will rebound 14 percent by December from Friday’s close.
“The gap must close at some point this year,” said Luca Paolini, chief strategist at Pictet Asset Management in London, referring to the wide dispersion. His firm oversees 139 billion euros ($152 billion). “There is some exaggerated concern about the systemic risk in the banking sector. The valuations seem extreme.”
While Credit Suisse Group AG said last week the selloff in banking shares is overdone, those in the Euro Stoxx 50 trade at 8.6 times projected profit, near a record low relative to the broader gauge. Deutsche Bank AG, hit by growing fears over its creditworthiness, was among those that fell to its lowest price ever this month, before rebounding as it reassured investors.
With a gauge of global market stress near its highest level since 2011, European investors are going for the safer bets. A FTSE index tracking defensive companies in the region -- those that tend to do better in times of market turmoil -- is near a record high relative to another one following cyclical shares.
Traders are favoring consumer and health-care stocks because of their stable earnings growth and dividend yields, according to BNP Paribas Fortis’s Philippe Gijsels. With bond rates turning negative in some countries, payouts of more than 3 percent at companies such as Sanofi and Unilever are especially attractive, he said.
“You’re almost forced to get into this market because of the negative interest rates and on the other hand you also want to get these stable companies with nice earnings,” said Gijsels, the chief strategy officer of BNP Paribas Fortis in Brussels. “The market has really been moving at two speeds since the start of the year. You can easily envision a world in which this premium gets even 10-15 percent higher.”