Chart of the week – Value for money

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US and European equity markets have gained roughly 14% so far this year[1], benefiting from the perception among investors that major central banks will not be raising interest rates any time soon, which removes one of the main 2019 constraints on equity market upside.

Are valuations also moving in sync or can we point to a gap here between US and European markets that could encourage investors to favour one over the other?

Assessing region and country relative valuations (see table), Wall Street looks expensive relative to Europe in price/earnings terms, with valuations one full standard deviation above the historical average, and even dearer in price-to-book and price-to-sales terms. Does that tell the full story? Actually, no. A look at the PEG ratio indicates that expected earnings growth is higher for US companies, which could well justify their higher relative market pricing.

Exhibit 1: Valuations – price/earnings are at average levels in most markets, although in the US, they look high relative to Europe

chart of the week - valuations

Data through 31 March 2019. Note: P = Price, E = Earnings (next-twelve-month), PEG = PE-EPS growth. Japan PE multiples since 2001, all other markets from 1987. Colours reflect z-score, with threshold at +/- 1 and +/- 0.5. Source: IBES, MSCI, FactSet, BNP Paribas Asset Management

So much for history. What of the outlook?

US purchasing managers indices (PMIs), which can be seen as a leading indicator of corporate spending and hiring plans, have been moving in a relatively narrow band for the last two years. The latest PMIs, covering both the manufacturing and the services sectors, showed a slight dip, possibly amid concerns over the chances of a near-term resolution of the Sino-US trade conflict and the tit-for-tat imposition of tariffs, which has eaten into the US corporate margins.

An adjunct factor has come in the form of rising wages in a tight US labour market. At this point, it is too early in the company earnings reporting season to determine how much these factors have affected earnings. Corporate earnings guidance, however, is currently less positive relative to the same period of 2018.

And for Europe?

PMIs for Europe kept skidding for much of last year before pulling out of the nosedive at the beginning of 2019. The latest data, for March, however, showed another drop in most major countries. A key concern has been weak demand from China and the impact that has on European, and particularly, German, exports.

The latest, better-than-expected, Chinese data, however, showed signs of economic stabilisation, and given the leading nature of the PMI, investors might now well expect an improvement in exports. This could mean that a brighter outlook for Europe as a whole is in the offing.

Would that put paid to concerns of a ‘Japanisation‘ of Europe, i.e. a prolonged spell of very modest GDP growth and deflation, and the accompanying underperformance of European equities – and bonds – relative to global assets? Indeed, we do not expect that to be Europe’s future.

[1] Source: MSCI, JPMorgan, Bloomberg, FactSet, BNP Paribas Asset Management. Data as at 29 March 2019.

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Daniel Morris

Senior investment strategist, CFA charterholder

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