With today’s rally, the S&P 500 index is now down only about 1% for the month of October. That’s quite incredible considering that the index was down more than 7% for the month just last week. While the U.S. indices have roared back, European stocks have remained weak throughout October. The Euro Stoxx 50 index is still down 5.5% in October, though it was down 13.5% at the intraday low last week.
As a result of Europe’s underperformance this month, the S&P 500 / Euro Stoxx 50 ratio has hit a new all-time high in October (intraday), indicating outperformance of U.S. stocks vs. Europe:
It’s interesting that U.S. stocks have felt much stronger since June 2012, but that the outperformance came mostly before that date. In the past 2 years, U.S. stocks have slightly outperformed (most of all of that in the past 6 weeks), but even the slew of negative European headlines has not caused a major performance difference. With October’s divergent performance, the SPX is now outperforming by nearly 8% in 2014, a substantial lead.
A big reason why I think European stocks have generally kept pace in the past 2 years is relative valuation. I discussed in a post last summer that European multinationals in similar businesses as U.S. multinationals were priced more cheaply for similar growth prospects:
However, the recent bounce is a reason for optimism, as the ratio tested its 2012 low and essentially bounced near there. Importantly, the ratio is now almost flat over the past 2 years, which is especially surprising since it feels like the U.S. has significantly outperformed the rest of the world since the fall 0f 2011. In fact, Europe has maintained a similar pace to the upside. The ratio might finally be turning after 6 years of severe underperformance for Europe (the ratio has halved since the end of 2007).
When I look at valuations of the stocks in the Euro Stoxx 50 index, the valuation differential significantly favors European names over U.S. stocks. 5 of the top component comparisons (with the usual caveat that this is a simplistic exercise):
- Sanofi – 14.5x P/E with 10-15% EPS growth projected, 3.5% dividend yield. Pfizer – 13.5x P/E with 5% EPS growth projected, 3.3% dividend yield.
- Total – 8.5x P/E with 0-5% EPS growth projected, 5.8% dividend yield. Exxon Mobil – 11.5x P/E with 5% EPS growth projected, 2.8% dividend yield.
- Siemens – 15.5x P/E with 20% EPS growth projected, 3.6% dividend yield. General Electric – 14.5x P/E with 10% EPS growth projected, 3.1% dividend yield.
- Daimler – 12x P/E with 15-20% EPS growth projected, 4% dividend yield. Ford – 11x P/E with 15-20% EPS growth projected, 2.4% dividend yield.
- Unilever – 18.5x P/E with with 10% EPS growth projected, 3.4% dividend yield. Procter and Gamble – 19x P/E with 10% EPS growth projected, 3.0% dividend yield.
Of those 5 large cap comparisons, Ford over Daimler is the only one that I would prefer. Once again, U.S. stocks look expensive vs. their global peers that are in similar businesses.
Fast forward to today, and the valuation differential still looks more favorable in the large cap European companies. Of course, that does not mean that the current underperformance has to turn any time soon. The biggest risk remains the European banking system, which remains woefully undercapitalized.
What it does indicate for me, though, is that negative headlines in Europe are not an obvious reason to sell European equities. A lot of negative news is priced into markets there. On the flip side, a lot of positive news is already priced into U.S. equities given their relative valuation. I view the odds that the performance spread narrows in the next year as significantly higher than continued relative outperformance by U.S. stocks.