Europe’s Recovery Is Weak, Warns Ecb

mario draghi

While the STOXX Europe 600 trades at 12.6 times next year’s expected earnings, according to StarMine, HSBC trades at 10.4 times, BP at 7.7 times, with Shell and Total both at 8.2 times. The amount of money invested in European large-cap value equities was 24 billion euros ($32.49 billion) by the end of August, half as much as five years ago, Morningstar data shows. “The common theme is catch-up by lagging assets. That’s a late-cycle theme,” said Christopher Potts, head of economics and strategy at Cheuvreux. “We’re not going to do it in six months. If you’re talking about the recovery of value in Europe, it’s a five-year idea. It took five years to kill that view and it’s going to take years for it to come back.” In 2011, the only other time in the past decade when the price/earnings gap between growth and value was as wide as it is now, the broad market retreat started around three months after that gap began to close. That could be an indicator of when the broader market rally may run out of steam this time although not necessarily. In 2000 the gap between growth and value stocks was narrow yet the overall market downturn did not begin until around five months after the gap began to close. In the past five years the MSCI Europe Value Index has underperformed growth by nearly a quarter, in the run-up to the 2000 market peak, the gap between the two was less than 5 percentage points. SMALLER POOL In the current market rally – European stocks rose in 14 of the last 16 months and the STOXX Europe 600 index is up by around a third in that time, trading near five-year highs – the pool of obviously cheap, “deep value” stocks for investors to choose from has already contracted. The number of STOXX Europe 600 companies trading below their 10-year average price/earnings ratio has halved to around 270 over the past two years. On the flip side, investors’ aversion to companies exposed to the economic cycle during recent years has left many well-established companies with healthy balance sheets trading at lower valuations than the overall market. In these cases, the distinction between value and quality stocks has been blurred. “The opportunity is not so much in deep value but in relative valuation within the European equity space, where you have a lot of cheap cyclicals that you can invest in and benefit from the cyclical upturn,” said Manu Vandenbulck, senior investment manager at ING Investment Management.

Europe’s cheap stocks set for a long catch-up rally

The euro is at eight-month highs against the dollar. It was given another boost Wednesday by news that Italy had averted the threat of snap elections , and the possibility that U.S. political gridlock may force the Federal Reserve to keep pumping money into the economy at full throttle. Draghi said he didn’t expect the U.S. to default — a risk if it doesn’t raise the limit on government borrowing later this month — and believes the government shutdown will be short-lived. “If it were to be protracted it would certainly be a risk for the U.S. and world recovery, so we have to have this present in our minds,” he said. Federal workers sound off on shutdown Draghi repeated previous guidance that interest rates would remain at current or lower levels for an extended period of time, but stressed there were other tools at the bank’s disposal, and none were off the table. Interbank lending rates remain higher than the ECB would like and lending to non-financial firms shrank further in August. Loans to households grew by 0.4%, but that rate has barely moved since the start of the year. Some economists now expect the ECB to launch a third long-term refinancing operation, or LTRO, before the end of the year to provide more cheap funds to eurozone banks.

That’s a late-cycle theme,” said Christopher Potts, head of economics and strategy at Cheuvreux. “We’re not going to do it in six months. If you’re talking about the recovery of value in Europe, it’s a five-year idea. It took five years to kill that view and it’s going to take years for it to come back.” In 2011, the only other time in the past decade when the price/earnings gap between growth and value was as wide as it is now, the broad market retreat started around three months after that gap began to close. That could be an indicator of when the broader market rally may run out of steam this time although not necessarily. In 2000 the gap between growth and value stocks was narrow yet the overall market downturn did not begin until around five months after the gap began to close. In the past five years the MSCI Europe Value Index has underperformed growth by nearly a quarter, in the run-up to the 2000 market peak, the gap between the two was less than 5 percentage points. SMALLER POOL In the current market rally – European stocks rose in 14 of the last 16 months and the STOXX Europe 600 index is up by around a third in that time, trading near five-year highs – the pool of obviously cheap, “deep value” stocks for investors to choose from has already contracted. The number of STOXX Europe 600 companies trading below their 10-year average price/earnings ratio has halved to around 270 over the past two years. On the flip side, investors’ aversion to companies exposed to the economic cycle during recent years has left many well-established companies with healthy balance sheets trading at lower valuations than the overall market. In these cases, the distinction between value and quality stocks has been blurred. “The opportunity is not so much in deep value but in relative valuation within the European equity space, where you have a lot of cheap cyclicals that you can invest in and benefit from the cyclical upturn,” said Manu Vandenbulck, senior investment manager at ING Investment Management.