Still meaningful value in equities
European equities have risen more than 200% since the 2009 financial crisis, but the market’s current dividend yield signals that investors should still expect meaningful returns from these levels, according to Thomas Buckingham, fund manager, Europe Strategic Dividend Fund, JP Morgan Asset Management.
With European dividend yields today hovering around 3.5%, this suggests that we can expect total returns in the high single digits, as much as 10% annualised in the next five years.
Buckingham says there are multiple pillars supporting European equities earnings growth:
- Increase in the money supply supports risk assets. He points out the sheer size and scale of the European Central Bank’s ambitious quantitative easing programme, which is projected to grow the central bank’s balance sheet by more than half. As a percentage of equity market capitalisation, ECB QE is nearly equivalent in scale to US QE 1, 2 and 3
- The weaker currency is a strong indicator of future GDP growth. On a trade weighted basis the Euro is now more than 20% below its highs. Buckingham thinks the velocity of this move represents the most powerful tailwind in approximately 20 years, if the euro stays flat on a trade weighted basis. The lower currency also translates as a massive positive input for European exporters.
- Lower oil prices are also supportive of European GDP. Because nearly all European countries are net importers, a 10% decline in oil prices directly translates in some countries to as much as a half of a percentage point of GDP growth. Also, lower oil prices have a huge benefit in boosting consumer confidence levels and supporting consumer spending.
With significant tailwinds supporting the outlook for earnings growth, Buckingham predicts that European equities will start to close the gap with US equities. Earnings growth for European equities has lagged their US counterparts by as much as 45% in recent years, but historically tight correlations suggest that European equities are due to snap back.
With this backdrop, Buckingham argues that European equities do not look stretched on a valuations basis. He admits that the market looks fairly valued on a P/E basis, but points out that we’re at cyclically depressed earnings levels relative to history. Therefore, using a cyclically adjusted P/E to judge valuations, which shows the market still has significant upside potential, makes more sense.
Buckingham is finding attractive investment opportunities in higher yielding European equities, which offer premium yields relative to the world’s other developed markets but aren’t any more expensive. In fact, he notes that on a median price to earnings basis, high yielding European stocks actually haven’t kept pace with the market average. European equities as a whole are trading on a current P/E ratio of approximately 17x, yet the market’s highest yielding stocks are just 14x.