Bloomberg News

Europe Stocks Cheapest to U.S. Since ’04 as Growth Decouples

February 01, 2012

(Updates index prices in ninth paragraph; adds geographic sales in paragraph after ‘International Revenue’ subheadline.)

Jan. 23 (Bloomberg) -- European equity valuations have fallen to the lowest levels since 2004 compared with the U.S., as economic forecasts between the two regions diverge by the most since 1998.

The Stoxx Europe 600 Index trades at 1.43 times book value, or assets minus liabilities, after falling 11 percent last year. That compares with 2.14 for the Standard & Poor’s 500 Index, according to data compiled by Bloomberg. The European gauge has been at least 30 percent cheaper for 69 straight days, the longest stretch in seven years. Economists forecast U.S. gross domestic product will expand 2.3 percent in 2012, compared with a 0.2 percent contraction in Europe.

Bulls say the gap provides the opportunity to buy bargains because profits among companies in the Stoxx 600 will rise an average of 9.8 percent in the next two years, bolstered by the growing American economy. U.S. GDP grew twice as fast as the euro zone in 2003 when equities began a five-year bull market. Bears say budget deficits will keep both regions from rebounding and that a recession in Europe will lead to losses everywhere.

“Even though the euro zone may be the largest economic bloc, the U.S. is the single largest country as an economy, so if we’re doing better there’s going to be an effect that’s going to benefit other areas of the world,” Mike Ryan, New York-based chief investment strategist at UBS Wealth Management Americas, which oversees $715 billion, said in a Jan. 19 phone interview. “It certainly does no harm and likely does good.”

American Premium

Investors are paying a premium for European companies that do the most business overseas, Bloomberg data show. ASML Holding NV, the region’s biggest manufacturer of chip equipment, has risen 48 percent since August and trades at 4.1 times book value. The company got 15 percent of 2010 sales from America. Daimler AG, the world’s largest maker of heavy-duty trucks, has risen 44 percent since November after saying U.S. demand is growing.

European companies will get 46 percent of 2011 revenue outside the region and the proportion for the largest companies is 57 percent, according to Morgan Stanley analysts. Businesses get about 14 percent of sales from the U.S., the estimates show.

The euro has weakened about 4 percent in the past three months, the worst performance among 10 currencies tracked by the Bloomberg Correlation-Weighted Indexes. A 10 percent gain in the dollar would spur a 1.8 percent advance in European earnings in 2012 and a 1.7 percent increase in stocks’ “fair value,” Morgan Stanley said in an Oct. 3 note to clients.

Confidence Jumps

Stocks advanced globally last week as first-time claims for U.S. jobless benefits slipped to an almost four-year low and German investor confidence jumped the most on record. The Stoxx 600 climbed 2.7 percent to 255.85 for its best annual start since 1997 and the S&P 500 gained 2 percent to 1,315.38, posting its biggest rally to start a year since 1997.

The Stoxx 600 rose 0.3 percent at 9:37 a.m. in New York today, while the S&P 500 gained 0.2 percent.

Fund managers are more bullish on American stocks than at any time since April 2010, according to a Bank of America Corp. survey released Jan. 17. The U.S. supplanted emerging markets as the most favored region for equities, while Europe was the least popular, falling to almost the lowest level on record, the survey found.

‘Noticeably Desynchronized’

“Unlike in the financial crisis of 2008, the global economies of today are noticeably desynchronized,” said Frances Hudson, who helps manage $241 billion at Standard Life Investments in Edinburgh. “The U.S. plus China and emerging markets should outweigh Europe. On that ground, to sell European companies down hard seems to be a little counterintuitive.”

Average economic growth in Brazil, Russia, India and China will top 6 percent next year, the World Bank estimated Jan. 17. Global GDP may increase 2.5 percent this year, down from an estimate of 3.6 percent in June and restrained by a 0.3 percent contraction in the euro area, the Washington-based agency said.

Equity valuations as measured against book value, or how much a company is worth in liquidation, fell below their decade averages in 2008 as the credit crisis began. They’ve yet to recover in the U.S. or Europe after concern Greece would default sent stocks in at least 35 countries into bear markets, or declines of more than 20 percent, in 2011.

The Stoxx 600 trades 25 percent below its 10-year average price-to-book value multiple even after a 62 percent rally since March 2009 lifted the multiple from 1.1. The S&P 500’s price-to- book multiple expanded by almost 50 percent since November 2008 as the index rallied 75 percent.

Growth Forecasts Gain

Forecasts for growth in the $15.2 trillion U.S. economy this year have risen since October. From a low of 2 percent, the median estimate in a survey of 72 economists has climbed to 2.3 percent, including a 0.2-point increase on Jan. 12 that represented the biggest one-day gain since the projections began.

In the 17-member euro area, the average forecast has declined from 1.8 percent in December 2010 to minus 0.2 percent now. The 27-nation European Union has a combined gross domestic product of $15.8 trillion.

“This is showing that the U.S. can decouple, which is good for us and it’s good for them,” Paul Zemsky, the New York-based head of asset allocation for ING Investment Management, said in a phone interview. His firm oversees $550 billion. “If the U.S. was in a recession at the same time that Europe had to go through this, that would be an even bigger disaster.”

Default Speculation

Borrowing costs from Italy to Spain surged last year as investors speculated countries would default. Spending will outpace collections by 8 percent this year in Greece and 10 percent in Ireland, according to the European Commission. Projections for economic growth have shrunk after Spain, Italy and the U.K. enacted spending cuts to reduce the deficits.

Euro-region borrowing was more than 70 percent of gross domestic product last year, data from the EU’s statistics office show. In the U.S., where spending is outpacing revenue by 9.6 percent, gross debt is 98 percent of GDP, according to data compiled by the Treasury Department.

“Our core thesis is that throughout the West, more debt has been accumulated over the past four decades than can ever be paid back,” said Tim Price, chief investment director at PFP Group in London. “There is preliminary evidence that the U.S. economy is recovering. That is good to see but I fail to see how strong U.S. consumption can drag us out of the mess we are in.”

Rescue Fund

European governments and the International Monetary Fund are financing 256 billion euros ($331 billion) in Greek, Irish and Portuguese bailouts and plan a second package for Greece of 130 billion euros. In addition, the euro area has pledged a 500 billion-euro permanent rescue fund in case further aid is needed for distressed governments in the region.

ASML in Veldhoven, Netherlands, said Jan. 18 that orders from abroad will sustain growth and make up for any slowdown in its home region amid the sovereign-debt crisis. The company gets most of its revenue in Asia, and 15 percent out of the U.S.

Daimler, based in Stuttgart, Germany, said last month its commercial-vehicle plants will remain at full production in the first quarter as demand in North America pushed new orders to a four-year high. The company, which counts the U.S. as its largest market, trades at 1.17 times book value, compared with a ratio of 0.98 for the broader Stoxx 600 Automobiles & Parts Index.

International Revenue

ASML and Daimler are among 143 companies in the Stoxx 600 that in their latest year reported less than 40 percent of total revenue coming from western Europe, according to Bloomberg data.

“We are seeing strong growth in the U.S. and have several European markets that raise a significant part of their revenue overseas,” James Swanson, who helps oversee $200 billion as chief investment strategist at MFS Investment Management, said in a Jan. 11 interview in London. “That, at a time when the euro has dropped, gives earnings a very important buffer.”

Kevin Rendino, a money manager at New York-based BlackRock Inc., says signs Europe and the U.S. are decoupling is positive for equities. While U.S. stocks and the euro rose or fell in tandem in 2011 as concerns over Europe’s debt crisis eased or grew, that correlation has broken down this year, he said.

The S&P 500 was little changed last year as the European currency declined 3.2 percent, and the so-called 30-day correlation coefficient between them reached a record 0.91 in November. Since Nov. 30, the euro has dropped 4 percent against the greenback while the U.S. equities gauge has gained 4.9 percent. The ratio has slipped to 0.66, Bloomberg data show.

“I understand that Europe’s weak but that doesn’t mean the rest of the globe has to be weak,” Rendino, who helps oversee $3.3 trillion, said in an interview. “There’s been some decoupling.”

--With assistance from Jonathan Stearns in Brussels, Jana Randow in Frankfurt and Whitney Kisling, Inyoung Hwang and Constantin Cosereanu in New York. Editors: Chris Nagi, Nick Baker

To contact the reporter on this story: Alexis Xydias in London at axydias@bloomberg.net

To contact the editor responsible for this story: Andrew Rummer at arummer@bloomberg.net


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