Investors who were invested in European equities in recent years cannot complain. Since the low in 2009 the STOXX600 index has risen 20% p.a. on a total return basis, which is significantly more than the expected long-term run rate of 8 to 10%. The reasons are obvious: continuously falling interest rates and an accommodating loose monetary policy by central banks. On the search for yield investors had little choice but to go into riskier alternatives, namely equities. Market mechanisms are one thing, but in the long run valuations matter, so what is the status quo on European stock markets?
From a fundamental point of view, markets are a bit more than fairly valued with price-earnings ratios between 16 and 20. If we take historical low interest rates into account markets are not so expensive any more, and that is also true for interest rates being 300bp higher, which is definitely not on the cards. So where is the upside? Corporate earnings in Europe stagnated for the last three years, more or less. Unlike in the US, where earnings are 25% higher than at the last peak in 2007, earnings in Europe are 30% lower. Profit margins of US companies are at an all time high, and in Europe they are 30% below the last peak. The explanation lies in a much stronger and more adaptable US economy. However, the most recently published data show a recovery in Europe, triggered by falling oil prices and a weak euro. With the exception of Greece even the European peripheral countries are recovering. For the first time since years, growth rates are being revised upwards, for 2016 the consensus is significantly above 2% GDP growth, numbers not expected for years. For corporate earnings, the effect should be even stronger, thanks to past savings programs (operating leverage) and currency-related competitive advantages, which should lead to significant higher profits.
Investors in search of running yields have a hard time, given that interest rates for government and corporate bonds are at historical lows. The spread between dividend yields and investment grade corporate yields is at an all time high.
Valuations do not seem to be too expensive, and proven mantras need to be rewritten sometimes, thus: "Buy in May and stay".
Author:
Horst Simbürger, MSc, CEFA
Chief Investment Officer
VOLKSBANK INVESTMENTS
29 April 2015
Note
Wiener Börse AG would explicitly like to point out that the data and calculations given in this report are historic values, which do not permit any conclusions as regards future developments or value stability. Price fluctuations and loss of capital are possible in securities trading. The contribution is the personal opinion of the analyst and does not constitute a financial analysis or a recommendation for investment by the exchange operating company, Wiener Börse AG.