25 Jul OUR TACTICAL CALL: EUROPE INC.
Since the end of the 2008 financial crisis, the S&P 500 has outperformed the MSCI EAFE by 59% and the Euro Stoxx 600 by 49%, making the U.S. the ultimate destination for global investors seeking solid, less risky assets in a politically uncertain world.
However, history shows that relative performance between U.S. and international markets is cyclical, and over the past year the performance of international stocks has strengthened relative to U.S. This turning point in market leadership is being driven by several factors overseas, including lower valuations, aggressive monetary accommodation and improving economies. It also reflects the fact that after producing stellar, double-digit returns for much of the past 5 years, U.S. equities have started to become a crowded trade.
After delivering less than half the total return of U.S. equities over the past eight years, European stocks are starting to gain traction. The Stoxx Europe 600 Index is up more than 15% this year, by contrast, the S&P 500 Index has gained around 5.7% over the same period (see graph below).
Although U.S. stocks are likely to continue moving higher in this “Goldilocks” economy, investors have begun to recognize that the best opportunities no longer lie in the United States.
In this month’s Thinking Man, we discuss why we believe Europe offers a compelling opportunity as a short-term tactical call within our client portfolios. Valuations, EPS growth, Monetary Policy Divergence favoring Europe, labor market slack and a “calmer” political landscape for the remainder of the year are some of the reasons behind our view.
Over the course of this eight-year bull run, U.S. equities have outperformed European equities by more than double, with the S&P 500 index returning 215% while the Stoxx Europe 600 index returned just 105% in the same span of time.
U.S. fundamentals still look promising and economic growth is decent. Profits are rising and interest rates still remain low. However, the U.S. is now in its eighth year of economic expansion, and diminished slack in the economy should drag on earnings growth going forward. Annual real GDP growth over the next five years is unlikely to average more than 2% and nominal GDP growth is unlikely to exceed 5%. From a historical standpoint, U.S. valuations seem high, trading at 18x.
In contrast, Europe’s current forward P/E at 14.9 times is just 2% above its 25-year average. Analysts in Europe, while probably still a little too optimistic in forecasting an 14% 2017 earnings jump, may end up being more accurate than their U.S. counterparts. In addition, the average dividend yield on the MSCI-Europe index is 3.2% compared to 2.0% on the S&P 500 (see table below).