Why buy European stocks? For Kerry Craig, the answer is, why not?
Craig, a global strategist at JPMorgan Asset Management in London, said European shares look like a bargain next to bonds. Corporate profits are picking up, while yields — already negative in some nations— can scarcely go lower. Plus, investors’ worst fears about Greece and Ukraine have receded.
“A lot of the negative stuff that was supposed to blow up in the past month didn’t,” Craig said. “We are getting to the point where even a bond guy will tell you to buy stocks.”
His view is ratified by what is known as the Fed model, a valuation metric that compares the equity market’s earnings yield to the rate on government bonds. While the measure is not unanimously embraced, under it, European stocks have never looked like a better buy — even after the Euro STOXX 50 Index jumped 14 percent so far this year in its best start to a year ever.
Estimated profits as a proportion of share prices in the Euro STOXX 50 come out to 6.4 percent, 11 times more than government debt rates as measured by the Bloomberg Eurozone Sovereign Bond Index. The earnings yield reached a 16-month high of 7.9 percent last month.
Investors poured US$11 billion into European share funds in the two weeks through Wednesday last week, including the biggest weekly inflow on record, while withdrawing US$315 million from government debt, according to a Bank of America Corp report citing EPFR Global data. Fredrik Nerbrand, global head of asset allocation at HSBC Holdings PLC, boosted his European equity position last month and cut German bunds.
“That was partly because of valuations, but also because we are starting to see evidence of a turnaround in Europe,” he said by telephone from London. “You want to be an owner of European risk, especially after the pro-cyclical [European Central Bank] move.”
After the US experiment with quantitative easing, the Standard & Poor’s 500 Index more than tripled, reaching a record last week, and company earnings doubled. The prospects of increased stimulus from the ECB under bank President Mario Draghi spurred a 25 percent rally in the Euro STOXX 50 since October last year as bond yields across Germany, Finland, France and the Netherlands turned negative.
Even with the index of European shares at an almost seven-year high, some equities look cheap.
Deutsche Bank AG and Societe Generale SA have both jumped 18 percent this year, while their valuations of about 10 times projected earnings are at least 9 percent away from their peaks last year. Following a 42 percent rally this year, Renault SA’s 9.4 multiple is still below the average for European carmakers.
“The game is going to be which company generates the best profits, because I want to be where the earnings growth will give me the biggest return,” said William Hobbs, head of equity strategy at Barclays PLC’s wealth-management unit in London. “It is going to be a tricky time for fixed-income markets, and equities are still where your bread is best buttered.”
Speculation that Draghi’s policies will help improve economic growth as the euro weakens has helped boost bets that corporate earnings will increase. Profit at STOXX Europe 600 Index companies is expected to rise 7.3 percent this year, according to the average analyst estimate compiled by Bloomberg. That is more than triple the projected increase for S&P 500 members.
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