European Stocks On A Tear But Still Look Cheap

European Stocks On A Tear But Still Look Cheap

The European Stoxx 600 index signed off last week on a high note. It is set to clock its ninth monthly gain during 2013, says Bloomberg. European equities have so far returned 16% in 2013, and most fund managers report that investors are still bullish on Europe.

Since a picture is worth a thousand words this is an opportune moment to study the European stocks story as told by a collection of charts made available in the ‘Strategy Data Gallery’ for Europe by Morgan Stanley analysts Graham Secker, Ronan Carr, Matthew Garman, Krupa Patel and Hanyi Lim.

European stocks’ trend

Technically, the MSCI Europe is trading above both its 50-day and 200-day moving averages, signifying that a long-term bullish trend is in place, according to this chart below from the Strategy Data Gallery.

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In the latter half of 2012, the 50-day average crossed above the 200-day average, a technical event known by the evocative term ‘Golden Cross,’ and which heralds a bullish trend in the making.


Interestingly, the current Price Earnings ratio (on a trailing basis) of 16.5 for MSCI Europe, is poised just above its long-term average of ~15 as seen in the chart below. This is not so high when compared to the heady heights seen around the year 2000, and it appears there is some headroom yet for price earning multiples to rise.


Similarly, the Price to Book ratio of 1.82 for MSCI Europe is also just nudging its long-term average, the horizontal line in the chart below.


If we changed the yardstick to forward earning multiples, the current reading of 13.4 for the Price to Earnings (next 12 months estimate) ratio is poised at the level of the historical average, as per the chart below.


However, the forward ratio of Price to Book Value is still short of its long-term average according to this chart.


If you wanted a more ‘wide-angle’ picture of valuations, the Shiller Price Earnings ratio is useful because it is computed using inflation-adjusted price to 10-year average earnings. We find from the chart below that this ratio, currently computed as 14.2 for MSCI Europe, is running far below the historical average (the upper horizontal blue in darker blue).


By these counts, therefore, European stocks do not appear to be overpriced in the context of their long-term price earning multiples.

Hedge funds’ net positions at four year highs

Hedge funds are sophisticated investors and their positioning offers interesting insights into the likely future trends in the market. The chart below shows that hedge funds have been steadily increasing their net exposure to European equities since the second half of 2012. Their net exposure was relatively flat in the last six months but is now moving up again – in fact it is at its highest point since October 2009, as per the chart below. (Note: Net exposure = (Long Exposure – Short Exposure)/Fund Equity)


Operational metrics (EBITDA) projected to improve

The chart below shows that European EBITDA margins are on an uptrend after 2012, and forecast to improve going into 2015. This is an encouraging outlook for Europe from Morgan Stanley.


Debt levels projected to fall steeply

According to the chart below European debt-equity ratios will continue to fall  – a trend holding since the financial crisis. The projections show that 2015 debt-to-equity would be lower than the earlier low seen in 1994-95.


Sector price multiples 2014

In the chart below, note that the PE ratios of the following industry groups are projected to trade at substantial premiums to that of the MSCI Europe index during 2014:

Semiconductors: 81%

Household & Personal: 49%

Retailing: 45%

Industry groups at a discount:

Energy: -27%

Autos & Comps: -27%

Banks: -16%


Where will the MSCI Europe index be a year hence?

In the best case, Morgan Stanley forecasts a 23% upside from present levels to a level of 1,654 in November 2014. The bear case is for a 28% fall to 971.


Base case: “European EPS grows 9% and 10% in 2014 and 2015, reflecting a return to normalcy in the DM macro outlook. DM economies continue their recovery, while unconventional monetary policy fades and bond yields drift higher. Our target of 1380 assumes a N12M PE of 12.5x,” say the analysts.


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Saul Griffith is an investor in stocks, commodities and forex, writing under a pen name. Saul has top accounting qualifications and extensive experience in industry and the financial markets. He also has an abiding interest in breaking news that could be a harbinger of new trends and give insight into an instrument’s potential for providing value, growth or yield.
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