Cheap Valuations No Panacea For European Equities

By Farah Elbahrawy and Sagarika Jaisinghani, Bloomberg markets live reporters and strategists

Even a near-record discount for European stocks relative to the US isn’t proving enough to entice investors worried about a slowing economy and weakening profits.

After starting the year well ahead of the S&P 500, the Stoxx Europe 600 lost ground from May onward as the buzz around artificial intelligence fired up technology stocks across the Atlantic. Worries about a regional recession have also fueled an exodus from European stock funds, and the index is back to underperforming US stocks in dollar terms for the full year.

That’s a frustrating turn of events for equity bulls who were banking on a 35% discount in Europe’s price-to-earnings ratio — almost the lowest on record — to rekindle investor interest. Wall Street strategists say the gap isn’t closing any time soon.

Forecasters from Bank of America to Deutsche Bank expect the S&P 500 to hit a record high in 2024. The outlook for European benchmarks is a lot more timid, with earnings expected to rise just 6.7% versus an 11% gain in the US, according to data compiled by Bloomberg Intelligence.

“We expect European stocks to underperform the US,” says Marija Veitmane, senior multi-asset strategist at State Street Global Markets. “We are already in a global manufacturing downturn and it’s really weighing on cyclical exporter markets like Europe.” While she agrees European stocks are relatively cheap, “unfortunately value tends to underperform in a recession,” she says.

Veitmane is not alone. A multi-asset portfolio team at Societe Generale says European stocks are likely to show no gains at all next year amid an economic slowdown. They see the region’s stocks potentially slumping nearly 10% early in the year — a starkly bearish stance compared with the US, where they expect the S&P 500 to flirt with its all-time peak.

The gloom has also been reflected in the investor exodus from the region this year. European stock funds had outflows for 37 straight weeks, according to a Bank of America note citing EPFR Global. Even Goldman Sachs’s Sharon Bell, who expects the Stoxx 600 to rise next year, says the main buyers will come from within Europe via corporate buybacks.

Not that the discount doesn’t matter. Part of Bell’s optimism stems from Europe’s “reasonable valuations.” And while JPMorgan’s Mislav Matejka is staying underweight on the euro zone versus the US for now, his team say they could potentially change that call through the first half of 2024 “given the increasingly attractive valuations.” Oliver Collin, co-head of European equities at Invesco, says that “European equities are one of the few equity markets to still be attractively priced relative to bonds.” 

But that’s not enough for bears like BofA’s Sebastian Raedler, who expects the Stoxx 600 to slide 15% halfway through the year. “We see scope for a meaningful deterioration in growth momentum ahead on the back of a weakening credit cycle,” he says.