European stocks are valued at their lowest relative to US stocks in 20 years. The setback in US tech stocks has fuelled hopes that the favourites will change. But the poor performance of German and Swiss companies speaks against Europe.
Since July 10, a clear change in favorites has been observed on the financial markets. The Magnificent Seven of the big US tech stocks have lost more than 10% of their market value. In contrast, the smaller US stocks in the much-cited small-cap index Russell 2000 have risen sharply. The Market has already described the development in detail.
The comeback of US small caps is seen as a good sign for a sustained upward trend. A bull market is considered more stable and sustainable when not just a good half dozen large stocks are rising, but rather as broad a part of the stock market as possible.
It wasn’t just smaller US companies that had lagged behind the Magnificent Seven for years. International stocks had performed even worse than US small caps. Measured by the price-earnings ratio, European stocks were valued 37% lower than US stocks at the beginning of July, according to investment strategists at Morgan Stanley. That is the largest discount in at least 20 years.
The setback of the Magnificent Seven and the US small caps catching up are raising hopes on the Old Continent that the valuation of local stocks could now also increase, even in comparison to US large caps. However, the key figures of European companies in comparison to their rivals across the Atlantic speak against this, as investment strategist Michael Cembalest of JP Morgan argued at the end of July. Small caps, value stocks and also stocks outside the USA are at their lowest valuation level in 20 years for an understandable reason, says Cembalest: earnings growth is weaker than in US blue chips.
Let us first look at the development of sales over the past decade. From a European perspective, the picture is shocking. The European Stoxx 600 and especially the German leading index DAX show a picture of stagnation. Within ten years, the sales of the largest German listed companies have grown by just 12%. The companies in the S&P 500 together achieved growth ten times as strong. The members of the SMI achieved a sales increase of 54%.
The situation is somewhat better when it comes to profits. The DAX members increased their profits by almost half. Since the increase in sales was modest, as shown above, the lion’s share of the increase in profits must come from cost-cutting measures and efficiency gains.
The members of the Swiss leading index increased their profits by two thirds. But the companies in the S&P 500 increased them by one and a half times in the same period.
Growth desert Europe
“Companies outside the US have been a profit desert over the past decade,” says JP Morgan strategist Cembalest. And given the data, it’s hard to disagree with him.
Stocks outside the US, together with value stocks and US small caps, formed “the unholy trinity of underperformance,” according to the US strategist’s harsh but fair verdict.
Cembalest sees no signs that this will change. “The poor earnings figures speak against a longer outperformance compared to US blue chips.” US small caps are the ones that have the most potential to catch up.
The company data clearly suggests one thing: if Europeans want to achieve better stock market performance, companies must first generate more growth. Preferably supported by a growth-promoting economic policy.
