European equities have consistently been traded on lower valuations than US stocks over the past few years, which has been mainly due to the political risk connected with the asset class.
“It is now logical that we start to see Europe’s high equity risk premium finally beginning to moderate,” said Jeff Taylor, head of European equities at Invesco Perpetual.
Brooks Ritchey, head of portfolio construction at K2 Advisors, added: “European equities have underperformed US equities over the past 10 years, and we expect this trend could reverse. We think European equities could benefit from favourable valuations, improving earnings growth and global reflation.”
Though the euro has made some gains against the dollar recently, it’s still cheap on a historical basis. The recent flurry of American companies trying to take advantage of this by snapping up ‘cheap’ European companies (Kraft Heinz chasing Unilever and paint manufacturer PPG going after AkzoNobel being only a couple of examples) is testimony of that.
M&A activity will drive up the share price of selected European companies in the months to come, and “many foreign investors have been avoiding the euro area because of political risk, and they may well return to European stock markets now,” says Romig.
But are European equities really that cheap? The answer is that, on a fundamental basis, they aren’t. European forward P/E ratios are slightly above their long-term average. However, on a relative basis the lights are still green.
