America has always been seen as the defiant younger upstart to Europe – full of brim and vigor and with the gumption to change the world, something that has also been reflected in its stock market, which regularly trades at higher multiples than Europe.
Because if Europe represented the “Old World” then surely the “New World” would have more promise.
But just as a Louis Vuitton T-shirt doesn’t perform any better than one from Hanes, investors are increasingly paying a premium for U.S. stocks.
With the S&P 500 at around 23 times forward earnings versus the 18 times for the MSCI Europe (excluding United Kingdom), investors continue to be overweight American outperformance.
And that leaves some upside potential for European equities because where expectations are lowest, is where opportunity is greatest.
There are several macro factors which could potentially favor a more robust European recovery, as global vaccinations get under way and export-oriented economies are likely to be the main beneficiaries, with consumer demand likely to soar.
And this global demand recovery is likely to benefit Europe disproportionately, since it is expected to be dominated by spending on luxury items and capital goods – two sectors that are well represented in European indices.
Tepid growth in the Eurozone is likely to also make a comeback from both public and private investment, and the pandemic has forced plenty of Europe’s companies to digitalize, after decades of resistance, creating new markets and opportunities.
Then there’s the inevitability of the U.S. Federal Reserve eventually tapering its asset purchases, which will steepen the yield curve.
Negative rates and flat curves are not good for the financial sector because banks pay short interest rates on deposits and receive long rates on the loans they extend – so flat curves depress net interest margins, making bank stocks less attractive.
But those negative rates and flat curves are great for the tech sector and other growth stocks, given the reduction in the rate at which future earnings are discounted – when global yield curves steepen and rates head up, financial stocks are likely to make a comeback again, outperforming tech.
Again, that turnaround would help Europe’s prospects, where financials feature larger and tech has a much smaller turnout on the continent’s benchmarks – MSCI Europe has a much higher weight in financials at 15% compared to the S&P 500's 11%.
Conversely, the MSCI Europe also has a much lower weightage in tech, at just 10% versus the S&P 500 which is at 28%.
Finally, one of the biggest concerns with respect to Europe has always been a monetary union without a fiscal union.
The pandemic has changed that – with the E.U.’s recovery fund going a long way to strengthening Europe’s institutional architecture and strengthening integration.
At a time when other markets, particularly the U.S. seem frothy, Europe may be offering some decent value.
After all, you may drink a New World wine daily, but for a celebration, there’s nothing like a vino from the old country.
