European stocks are cheap relative to US equities from a valuation perspective. And they got even cheaper recently, dipping after French President Emmanuel Macron called for a snap election amid the rise of the National Rally party’s Marine Le Pen.
All this begs the question as to whether American tourists now streaming into Europe on the back of the strong US dollar should consider bringing back stocks from the continent along with their souvenirs.
Valuations are attractive in Europe, as they have been for quite some time, at a price-to-earnings ratio (P/E) of 13.5. That’s a healthy 36 percent below the P/E of the S&P 500 and, as Adam Turnquist, chief technical strategist for LPL Financial, points out, a full 5 percent below its 10-year average.
“As Europe's economic activity potentially picks up as rate cuts take hold and inflation potentially eases further, these valuations could expand. An end to the war in Ukraine and the start of the rebuilding there would help, as would greater political stability,” Turnquist said.
Another potential bullish case for European equities is earnings growth, which Turnquist sees as respectable and improving. That still lags the US, which is getting a boost from its world-beating – and very richly valued – tech companies.
As for the continent’s rising political uncertainty, Turnquist sees the rise in right wing nationalism as less of an existential threat to the Eurozone as the European debt crisis was in the early 2010s.
Nevertheless, despite the attractive valuation and greater political stability than the market is implying, Turnquist does not favor overweighting European stocks.
“Investing in Europe does make sense,” he said. “But with slower earnings growth, less exposure to powerful trends in technology such as AI, and weak relative strength, the case for European equities over the US is tough to make. Still, we think the outlook is good enough for an allocation near neutral.”
Daniel Lash, certified financial planner at VLP Financial Advisors, says European equities have performed reasonably well in local currencies but have underperformed in the US due to the continued strength of the dollar.
“If, or more likely when, the dollar begins to weaken in the near future, then European equities performance will be better for US investors,” Lash said.
He adds that while valuations are also much lower for European stocks relative to US stocks, much of this is also to do with slow economic growth in Europe relative to the US, a pattern that has been in place for the past decade.
“As a wealth manager for clients, we have decreased our allocation to international stocks over the past five years and currently have approximately 15 percent allocated to international stocks, which is significantly lower than the 25 to 35 percent most asset managers recommend for retail investors,” he said.
Stephen Kolano, chief investment officer at Integrated Partners, notes that the discount relative to US stocks has been in place for some time, so it’s a matter of a catalyst unlocking some of the potential in European equities.
“Getting through the elections in both France and the United Kingdom will help to reduce uncertainty to some extent in the coming months. Potential interest rate cuts in the US may help strengthen the euro to the dollar and ease some of the inflationary pressures in the commodity markets given Europe is a net importer of oil,” Kolano said.
“Investors may need to look opportunistically in Europe at the country and company level and not the broad region in order to unlock the greatest potential returns,” he added.
If an investor is interested in taking a flyer or two on a European name, they need to keep currency exposure in mind, according to Nick Codola, senior portfolio manager at Brinker Capital Investments.
“Considering that central banks like the ECB are starting to cut, and the dollar at the moment still is the reserve currency of the world, it may be prudent to hedge the currency exposure,” Codola said. “Conversely, if the US dips into a recession while foreign markets start to rally, unhedged exposure to international equities would be more advantageous. Overall, hedging half of the equity exposure may be a prudent investment decision.”
Still, Sean Beznicki, director of investments at VLP Financial Advisors, said the recent selling in European assets due to “a specific French political issue” might be an overreaction that could create a buying opportunity.
“If upcoming French election results do not significantly disrupt the political landscape or economy, and the team continues to see improvements in European PMIs as global growth recovers, then the current dip could provide an attractive entry point for decent quality European proxies that are well-positioned for a global upturn in goods demand,” Beznicki said.
So maybe those American tourists should save some space in their suitcases just in case.
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