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European Equities Offer Promise

After all the recent headlines about the European fiscal crisis and the impending doom of the euro, investing in the European equity markets may sound like folly. Taking a closer look at the developed markets of Europe, however, we think we’re approaching a good time to buy their equities. We don’t think these markets are going to turn around overnight, but we do agree with Wall Street powerhouses such as Credit Suisse and Bank of America Merrill Lynch that European equity markets are a good bet for the future.

In this blog post, we’re going to take a look at the international markets represented in the MSCI EAFE Index. “EAFE” stands for Europe, Australia, and the Far East, but the index actually includes only the developed countries in these regions: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

Here’s why we believe that there are strong investment opportunities in Europe and other developed markets such as Australia and Japan:

  1. Low interest rates. The European Central Bank is highly motivated to keep interest rates low to help foster economic recovery in the euro zone. While investors have been inching away from American markets because the Federal Reserve has announced that it will be tapering off its economic stimulus in September, the European Central Bank shows no signs of following that lead.
  2. Less austerity. As in the United States, banks and corporations have been the beneficiaries of this “quantitative easing.” Meanwhile, individual Europeans have suffered the effects of severe austerity measures dictated by the European Central Bank as a condition of economic help. Many non-Germans think this austerity has gone too far and that the region will not recover unless the weaker economies are allowed to spend more. It appears that this view is gaining traction.
  3. European corporate earnings are rising. It may seem counterintuitive that European corporate earnings are performing strongly despite the economic downturn in the region. However, corporations like Nestle and BMW have used the current economic climate to focus on their market shares in the developing world, leading to increased access in previously untapped markets. In the long run, this should result in healthier and more resilient corporations, which in turn suggests better-performing equities.
  4. Low price-to-earnings ratios. The MSCI Europe Index is trading at a current price-to-earnings (P/E) ratio of around 11.6x, significantly lower than the S&P 500’s average P/E of about 14x. This suggests that European and other developed market equities are underrepresented in the average portfolio. We think this indicates a good time to buy.
  5. Historical return on investment. Returns in the European equity markets have been similar to those in the US over time. Comparing the return of the S&P 500 to the MSCI EAFE Index, we find that the 30-year return of S&P 500 is 10.8% while MSCI EAFE returned 9.8%. Surprisingly, MSCI EAFE actually did better over the last 10 years: 8.5% compared to the S&P 500’s 7.6%. In fact, it is only over the last 5 years that the European markets have underperformed the US markets. That situation appears to be changing: the S&P 500’s year-to-date performance is 25% and MSCI EAFE’s is 24%.

We have had reduced exposure to international developed markets in our portfolios recently because the European economy was doing worse than the US economy. Now that economic data indicates that the recession is Europe has ended, we believe it is time for our clients to begin gradually increasing the allocation that they have to European and other international developed markets.

Please feel free to contact us with any questions by calling us at (925) 365-1533 or sending an e-mail to lifeplan@accretivewealth.com

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